This paper explores how employment among an educated
workforce depends on production technology represented by factor substitution
and factor-augmenting technical progress. We consider a variant of the Diamond
overlapping generations model that can explain the empirical finding about the
elasticity of substitution being less than unity observed in some developed
economies. Depending on factor substitution, a decline in the wage rate has
positive and negative effects on employment. When the elasticity of
substitution is less than unity, a low wage rate can imply a low employment
rate as well as a low human capital level. Given the elasticity of
substitution, being less than unity, labor-augmenting technical progress can
decrease the employment rate and human capital level via a decrease in the
marginal product of labor.
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