One method for evaluating the effect of technological change on production is in terms of changes in the amount of capital (K) and labor (L) used in production, assuming of course that K and L are the only two factors of production. We recognize that intermediate materials and services, and even money, are also utilized in producing goods and services. For expositional purposes, we focus on these two inputs only. The simplest classification scheme assumes that technological change alters the input mix for a given level of output. For a given level of output and input price ratio, a labor-saving technological change results in a higher capital-to-labor ratio; a capital-saving technological change results in a lower capital-to-labor ratio; and a neutral technological change results in an unchanged capital-to-labor ratio.
Consider isoquant I in Figure 4.1, which corresponds to an output level of Q*. A labor-saving technological change is illustrated as isoquant I shifting inward to point A, where the capital-to-labor ratio is higher than along the ray K/L. Similarly, a capital-saving technological change is illustrated as isoquant I shifting inward to point B where the capital-to-labor ratio is lower than along ray K/L. A neutral technological change results in an inward shift of isoquant I to point C. At point C, Q* is produced with an unchanged ratio of capital to labor but with proportionally less of each input.
This factor-saving conceptualization of technological change implicitly assumes that technology leads to cost-reducing changes in the production process, rather than to new or improved quality products. Very roughly, this notion highlights the distinction between a process innovation and a product innovation, a subject we will return to in Chapter 9 where we discuss empirical analyses of the impact of R&D on productivity growth.
This factor-saving classification scheme is most applicable at the microeconomic - plant, firm, or industry - level with a focus on the short run when output levels can meaningfully be thought of as remaining constant. The classification scheme represents an unrealistic starting point for a macroeconomic taxonomy when output levels will change.
Alternative factor-saving classification schemes dominate the very early technological change literature and are discussed below. The schemes are based not