A Dynamic Theory of Labor-AI Substitution and Market Creation: Modeling Wages, Innovation, and Sustained Adoption in the Age of Intelligent Automation
Abstract
This paper proposes a new economic theory that models the dynamic interaction between artificial intelligence (AI), labor wages, innovation-driven job creation, and the sustainability of AI adoption. Built upon three core hypotheses, we argue: (1) labor wages in AI-augmented economies will be determined by the efficiency gains of AI relative to human labor; (2) the number of new job opportunities is directly proportional to AI's productivity in generating novel inventions and innovations; and (3) the sustainability of AI adoption depends on how rapidly AI contributes to market expansion and improves firm-level and macroeconomic performance. We formalize these hypotheses into a system of solvable dynamic equations involving endogenous returns on AI investment, invention-driven job elasticity, and market expansion velocity. The paper offers a mathematical foundation for simulating sector-specific scenarios and provides policy recommendations for balancing efficiency and equity in labor-AI transitions. A numerical example from a manufacturing sector undergoing partial automation is presented. We conclude by outlining limitations and directions for future research in adaptive macroeconomic modeling and AI policy forecasting.
Theoretical and Empirical Background
1. Labor Substitution and Efficiency Theories
1.1. Classical and Neoclassical Foundations
Classical economists such as David Ricardo and John Stuart Mill considered labor as a central input to production, but it was the neoclassical synthesis that mathematically formalized the substitutability between labor (L) and capital (K). Using a standard production function---often Cobb-Douglas:
Y=AKL1Y = A \cdot K^\alpha \cdot L^{1 - \alpha}
---economists modeled output YY as a function of inputs, with marginal productivity driving the allocation of income:
w=YL,r=YKw = \frac{\partial Y}{\partial L}, \quad r = \frac{\partial Y}{\partial K}
where ww is the wage rate and rr the return to capital. This framework assumes diminishing marginal returns and allows substitution between labor and capital depending on relative productivity and cost.
