Econ 802

Advanced Economic Concepts and Applications

The Second Law of Demand: Le Chatelier E¤ects
Kevin Tsui

Consider the (conditional) factor demand equations:

xC
i = xi (w1 ; :::; wk ; y)

for i = 1; :::; k:
Taking total di¤erentials we obtain
@xi @xi
dxC
i = dw1 + ::: + dwk ;
@w1 @wk
which can be written as
dxC
i w1 @xi dw1 wk @xi dwk
= + ::: + ;
xi xi @w1 w1 xi @wk wk
or equivalently,
d log xC C C
i = "i1 d log w1 + ::: + "ik d log wk :

Suppose there is an increase in the cost of factor 1 (i.e. d log w1 > 0; d log w2 =
::: = d log wk 1 = 0). Assuming that in the short run the quantity of input k is …xed,
so that all the adjustment in the factor market for input k will take place through
its price (i.e. d log wk 6= 0). We have,

d log xC C C
i = "i1 d log w1 + "ik d log wk for i = 1; :::; k 1

and
0 = d log xC C C
k = "k1 d log w1 + "kk d log wk :

The last equation implies

"C
k1
d log wk = C
d log w1 :
"kk
Upon substituting, we havethe
"C C
ik "k1 "C C
ik "k1
d log xC C
i = "i1 d log w1 d log w1 = "C
i1 d log w1 :
"Ckk "Ckk

1
 "C C
1k "k1 "C C
1k "k1
When i = 1; d log xC C
1 = "11 C
"kk
d log w1 : Since the term C
"kk
is unam-
"C C
1k "k1
biguously positive, "C 11 "C
> "C 11 : In other words, the fact that input k is
kk
…xed in the short run reduces the e¤ects of the change in price of factor 1 on the
quantity of the factor with respect to what they will be in the long run. In the long
run, all the e¤ect of the change in w1 will have gone through the quantity of factor
k and the price of factor k will be unchanged with respect to its initial value.
For i = 2; :::; k 1; let’s suppose that input 1 and i are complements (i.e. "C i1 < 0).
C C
Furthermore, if "ik and "k1 have the same sign, the short run e¤ect is again smaller.
However, if 1 and i are substitutes (i.e. "Ci1 > 0), the short run e¤ect is indeed larger.
Other cases can be analyzed in a similar way.