Contemporary Labor Economics
11th Edition
ISBN: 9781259290602
Author: Campbell R. McConnell, Stanley L. Brue, David Macpherson
Publisher: McGraw-Hill Education
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Question
Chapter 2, Problem 2QS
To determine
Check whether the circumstances cause more hours or less hours to work.
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SUBSTITUTION AND INCOME EFFECTS
OF A WAGE INCREASE
When the wage rate increases from $10 to
$30 per hour, the worker's budget line shifts
from PQ to RQ.
In response, the worker moves from A to B
while decreasing work hours from 8 to 5.
The reduction in hours worked arises
because the income effect outweighs the
substitution effect.
In this case, the supply of labor curve is
backward bending.
Income
(dollars per
day)
720
240
w= $30
w= $10
12
16
www.
19
Substitution Effect
Income Effect
Derive the graph into a
backward bending labor
supply curve
Q
24
Hours of leisure
Explain in detail
Discuss the possible substitution effect and the income effect of an increase in income on leisure time.
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Consider an individual who initially works T-L. hours per week, where (T-L)>0. They earn an
hourly wage (W) and no non-labour income.
a) Draw a graph that reflects this individual's income-leisure constraint, utility-maximizing
indifference curve (U.) and choice of leisure hours (L.).
b) The government then implements a wage subsidy program in which worker wages are
increased by 10%. This wage subsidy program has no limits, so there is no phase-in/out.
This wage subsidy produces both an income effect and a substitution effect on the worker's
choice of leisure hours. Assume that the substītution effect is stronger than the income
effect.
On the same graph as part a, draw this individual's new income-leisure constraint, utility-
maximizing indifference curve (U.) and choice of leisure hours (L).
[Note: When incorporating the 10% wage subsidy into the graph in part b, I am not
expecting perfect precision. Just try your best to draw the new income-leisure constraint as…
Chapter 2 Solutions
Contemporary Labor Economics
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Similar questions
- Suppose the wage you are being paid per hour doubles form $15 to $30. Would you decide to work more hours or fewer hours ? Is there an income and substitution effect involved in your decision about how many hours you choose to work? If so, what is being substituted for what?arrow_forwardSay whether you agree or disagree with this statement and explain your reason: “If the income effect of a wage change dominates the substitution effect for a given household, and the household works longer hours following a wage change, wages must have risen.”arrow_forwardJane is lazy person while John is hard-working person. Use graphs to show that John has lower reservation wage than Jane?arrow_forward
- Discuss the possible substitution effect and the income effect of an increase in income on leisure time.arrow_forwardWhat happens to hours of work when the wage rate falls? Decompose the change in hours of work into income and substitution effects.arrow_forwardAssume that, in response to a wage increase, Professor C retires sooner. a. (4) Explain -VERY BRIEFLY- the income effect of the wage increase (on both consumption and leisure)? b. (4) Explain - VERY BRIEFLY- the substitution effect of the wage increase (on both consumption and leisure)? c. (2) Explain - VERY BRIEFLY- whether the substitution or income effect is larger (in terms of leisure / labour).arrow_forward
- Assume that a person earns $10 per hour and her non-labor income increases from $100 to$200. She also has 110 hours a week to decide either to work or leisure. a. Draw a budget constraint of this person.b. Draw an indifference curve to show the income and substitution effect of change innon-labor income. HINT: you can draw two separate graphs to show the effect ofsubstitution and income effects.arrow_forwardIncome $240 $192 0 15 16 17 a) Using the above diagram, decompose the effect of a wage decrease for this individual into Income Effect (IE) and Substitution Effect (SE). Leisure 24 b) How many hours of work is effected because of the IE? c) How many hours of work is effected because of the SE? d) What is the net effect of this wage decrease on hours of work for this individual?arrow_forwardAkua gains utility from consumption C and leisure L. The most leisure she can consume in any given week is 110 hours. Her utility function is U (C, L) = C × L. Akua receives 660 GHS each week from her great-grandmother—regardless of how much she works. a. What will be Akua’s marginal rate of substitution. b. What will be Akua’s reservation wage? (Explain in detail)arrow_forward
- A worker views leisure and income as “goods” and has an opportunity to work at an hourly wage of $15 per hour. a. Illustrate the worker’s opportunity set in a given 24-hour period. b. Suppose the worker is always willing to give up $11 of income for each hour of leisure. Do her preferences exhibit a diminishing marginal rate of substitution? How many hours per day will she choose to work?arrow_forwardDraw large and clear graphs. Show all your work. 1. What's the effect of a decrease in wage rates (w) on hours of work (explain the substitution and income effects), reservation wage and probability of entering the labor force? 2. What's the effect of a decrease in non-labor income (v) on hours of work (explain the income effect), reservation wage and probability of entering the labor force? 3. James earns $25 per hour for up to 45 hours of work each week. He is paid $40 per hour for every hour in excess of 45. James faces a 30 percent payroll tax on every dollar earned through work and receives $250 rent payment each week. Graph James' weekly budget line. 4. On separate graphs show and explain the effects of lump-sum cash transfers (cash transfer 1), cash transfers which allow for work at reduced wages (cash transfer 2), and the earned income tax credit on labor force participation rates.arrow_forwardI understand the substitution effect, but I really need to understand the Income effect. Please explain that and thank you in advanced ?arrow_forward
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