The substitution effect is an idea in economics that can understood pretty intuitively. When the price of some good rises relative to some alternative, people will tend to buy more of the alternative and less of the now more expensive good. If apples and oranges used to be the same price, but apples get more expensive while the price of oranges remains unchanged, people will tend to reduce the amount of apples they buy and get more oranges instead. And it’s worth remembering that this effect occurs with a change in relative prices, too – not merely absolute prices.

If apples used to be $1 and oranges $2, but then the price of apples increases to $1.50 while oranges remain at $2, this can increase the number of oranges sold. Even though the price of oranges hasn’t changed, and its price is still higher than the price of apples in absolute terms, the relative price between the two has changed. Previously, for the price of three oranges you used to be able to get six apples. Now, for the price of three oranges you can only get four apples. Different people will adjust in different ways depending on their own preference between these two, but overall we can expect to see a greater proportion of oranges sold than before. 

There is also a substitution effect for labor. As labor becomes more expensive, employers will tend to find substitutes for that labor. One way they can do this is by substituting workers with machines. This tends to happen over time on its own – as technology advances and becomes less expensive, the relative price of using automation as opposed to hiring workers falls, leading to increases in automation. But artificially increasing the price of labor also lowers the relative price of automation, causing more workers to be substituted with automation. 

Among the many things one can say about the state of California is that it never fails to provide opportunities to show economics in action. I previously wrote about how the $20 minimum wage for fast food workers was causing fewer people to eat at fast food establishments and instead go to dine-in restaurants:

So why would places that serve more expensive food be seeing their traffic increase, while the still-less-expensive fast food establishments see their traffic decline?

The answer is that even though the price of dine-in chains hasn’t fallen in absolute terms, it has still fallen in relative terms compared to fast food. Fast food and dine-in restaurants differ in terms of price, quality, and convenience. But with fast-food establishments being forced to increase their prices in the face of increased labor costs, the gap in price between fast food and dine-in establishments has gotten smaller without any change in the other two dimensions. As a result, people are seeing what it would cost them to get a basic combo at McDonalds and thinking “Well, if I’m going to have to pay this much just to get some McDonalds, I may as well pay just a little bit more and go to Chili’s instead.”

More recently, another change has been made by a major fast-food chain in California – Chipotle. After this wage increase was put into law, Chipotle has begun replacing employees with machines, as was detailed in this news report:

Chipotle has introduced two robots that can take over tasks normally done by its workers. 

The ‘autocado’ can peel, stone and cut an avocado for guacamole in 26 seconds. Meanwhile, a ‘digital makeline’ portions up salads and bowls based on orders on the app.

The machines are part of an automation drive that Chipotle bosses hope will cut down the number of workers needed – slashing rising labor costs. 

So, it is no surprise they are being put to use first in two of the Mexican chain’s restaurants in California, the company announced on Monday. 

The author of that news article raises the issue of how expensive automation might be:

It is not yet clear how the production costs of using Chipotle’s new machines compares to human labor when making Chipotle menu items.

But this is why it’s important to keep in mind that it’s the relative rather than absolute cost that drives these adjustments. Even if the costs of the new machine are more expensive than human labor in absolute terms, the new minimum wage law has still made the use of machines relatively less expensive compared to human labor than before. And that’s all that needs to happen for the substitution effect to kick in. 

As an aside, it’s also worth noting that many restaurants, fast-food and otherwise, have found a different substitute for employee labor than machines. They simply have the customer perform tasks they used to hire employees to do. At one of my favorite local restaurants, they used to have someone who took your order, but they don’t anymore. That person’s job consisted of having customers say what they wanted, then pushing some buttons on a computer to ring up the order. Now, they just have a self-serve kiosk and have the customers push those buttons themselves. When your food is ready, they don’t have servers come and bring the food to your table. They call out your order number, and you pick up the food from the counter and bring it to the table yourself. And when you’re done, you don’t leave your dishes behind to be bussed by an employee anymore. You bus your own tables – they have trays set out for you place your dirty dishes. Restaurants increasingly use customer labor to replace the cashier, the server, and the busser. 

I’ve said it before and I’ll say it again – for all its simplifications, the world would benefit from a greater application of Econ 101 than what we have today.