The tendency of firms to substitute away from a factor whose relative price has risen and toward a factor whose relative price has fallen is called the

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This is known as the input-substitution effect because firms are substituting one factor of production for another based on their relative prices. As the price of one input increases, the firm will switch to another input that has become relatively cheaper in order to minimize costs and maintain profits. The derived demand effect refers to changes in the demand for a factor of production due to changes in the demand for the final product. The diminishing returns effect occurs when adding more units of a factor of production leads to diminishing marginal returns. The output effect is a general term used to describe the overall impact of changes in input prices on the output of a firm.

The Tendency of Firms to Substitute Away from a Factor