Digital Strategy and Markets · Lecture 1

Substitutes and complements: can one input replace the other?

A service desk resolves tickets with two inputs: worker hours and AI capacity. The blue curve joins every input mix that resolves the day's tickets. Its shape answers one question: can you buy your way out of a missing input? One slider bends the shape, from inputs that must be used together to inputs that replace each other. The other slider changes the price of AI relative to a worker hour. Watch the cheapest mix respond.

0 = they must be used together (L-shape). 1 = they trade off smoothly. High = one can stand in for the other (straight line).
Baseline = 1.00. Lower it to make AI cheaper, the move that Moore's law made for forty years.
Cheapest mix: AI capacity
10.00
 
Cheapest mix: worker hours
10.00
 
Total cost per day
20.00
 
What to notice. Drag the first slider low: the curve bends into an L. Now cut the price of AI and watch the mix. It barely moves, because inputs that must be used together leave the firm nothing to reallocate. Now drag the slider high: the curve flattens toward a line, and the same price cut swings the mix hard. How strongly a firm responds to a price shock is the same thing as how replaceable its inputs are. This is also the week's evidence in miniature: Brynjolfsson and Hitt found that computers and organization are hard to replace for each other, which is why buying computers without reorganizing bought so little.