[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

machines increases to $3,500 each. Then, the more-automated process will cost
$17,500, while the less-automated process will cost $17,000. Both processes rise in cost,
but the less-automated process rises less. It now becomes the less costly method. As
a consequence, firms will switch from the more-automated process to the lessautomated
process. In this way, they are able to substitute away from the factor
whose price has risen (machines, in this case).
An increase in the price of any input shifts the cost function up. The amount by
which the cost function shifts up depends on several factors, including how much
of the input was being used in the first place and how easy it is to substitute other
inputs. If the production process uses a great deal of the input, then the shift will
be large. If there is a large increase in the price of an input, and the firm cannot
easily substitute other inputs, then the cost curve will shift up more than it would if
substitution of other inputs were easy.
In some cases, substitution is quick and easy; in other cases, it may take time
and be difficult. When the price of oil increased fourfold in 1973 and doubled again
in 1979, firms found many ways to economize on the use of oil. For instance, companies
switched from oil to natural gas (and in the case of electric power companies,
often to coal) as a source of energy. More energy-efficient cars and trucks were
constructed, often using lighter materials such as aluminum and plastics. These
substitutions took time, but they did eventually occur.
The principle of substitution should serve as a warning to those who think they
can raise prices without bearing any consequences. For example, Argentina has
almost a world monopoly on linseed oil. At one time, linseed oil was universally used
for making high-quality paints. Since there was no competition, Argentina decided
that it would raise the price of linseed oil, assuming everyone would have to pay it.
But as the price increased, paint manufacturers learned to substitute other natural
oils that could do almost as well.
Raising the price of labor (wages) provides another example. Unions in the auto
and steel industries successfully demanded higher wages for their members during
the boom periods of the 1960s and 1970s, and firms paid the higher wages. But at
the same time, the firms redoubled their efforts to mechanize their production and
to become less dependent on their labor force. Over time, these efforts were
successful and led to a decline in employment in those industries.
Case in Point
THE PRINCIPLE OF SUBSTITUTION AND
GLOBAL WARMING
In the two hundred years since the beginning of the industrial revolution, the amount
of carbon dioxide (CO 2 ) in the atmosphere has increased enormously, and concentrations
continue to rise. There is growing agreement among scientists that the
higher concentration of CO 2 and related gases (called greenhouse gases) will lead
to global warming, with potentially significant impacts on the environment. Reflecting
this consensus, the countries of the world signed an agreement in Rio de Janeiro in
148 ∂ CHAPTER 6 THE FIRM'S COSTS