Question

How can two inputs be substitutes in production and yet be classified as gross complements?

Answer 1

Two inputs are said to be substitutes when decreased use of one input in the production of output can be compensated by an increased use of another input. In such a case of substitute inputs an increase in the price of the one input will shift the demand of the other input either to the left or to the right depending upon which is stronger- the substitution effect or the scale effect. If the demand of one input shifts to the left because of an increase in the price of another input, then the scale effect dominates the substitution effect. In this case the two inputs are said to be gross complements.

For example if there is a firm which has both skilled and unskilled labors for a particular job. The unskilled and skilled labors are substitutes to each other. If the wage of unskilled labor increases then the firm would hire lesser number of unskilled workers and more of skilled workers. This is known as substitution effect. But if the scale of output decreases and as a result of that the firm now hires lesser number of skilled workers too even though skilled workers were used as a substitution for unskilled workers. In this case skilled workers and unskilled workers are known as gross complements. Here scale effect dominates substitution effect.