Economic growth and economic development 693

Introduction to Modern Economic Growth

Skill premium

Initial premium

Long-run relative
demand for skills

Long-run premium
Short-run
Response
Exogenous Shift in
Relative Supply

Figure 15.5. Dynamics of the skill premium in response to an
increase in the relative supply of skills, with a downward-sloping
endogenous-technology relative demand curve.
when σ > 2. In the context of substitution between skilled and unskilled workers, an elasticity of substitution much higher than 2 is unlikely. Most estimates
put the elasticity of substitution between 1.4 and 2. One would like to understand
whether σ > 2 is a feature of the specific model discussed here and how different assumptions about the technology of production or the innovation possibilities
frontier affect this result. This issue will be discussed in Section 15.4. Second, we
would like to understand the relationship between the market size effect and the
scale effects, in particular, whether the results on induced technological change are
an artifact of the scale effect (which many economists do not view as an attractive
feature of endogenous technological change models). Section 15.5 shows that this
is not the case and exactly the same results apply when scale effects are removed.
Third, we would like to apply these ideas to investigate whether there are reasons
for technological change to be endogenously labor-augmenting in the neoclassical
growth model. This will be investigated in Section 15.6. Finally, it is also useful to
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