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 3QS
To determine
Impact of income effect and substitution effect on wage.
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Students have asked these similar questions
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
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?
Explain in detail
Discuss the possible substitution effect and the income effect of an increase in income on leisure time.
Chapter 2 Solutions
Contemporary Labor Economics
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Similar questions
- Winona has 80 hours to divide between leisure and labor. Her utility function is u(r,c) = f(r) + c, when r represents hours of leisure,c represents dollars of consumption, and f is strictly concave. Winona’s wage is w0= $15/hr. initially, then it rises to w1= $20/hr. (i) Explain what happens to Winona’s labor supply when the wage rises,and why. (ii) Explain how the answer to (i) would change if Winona were to win a lottery.arrow_forwardUsing indifference curve analysis, show the effects of an increase in the hourly wage rate on labor supply (hours of work) and earnings. Identify the income and substitution effects.arrow_forwardWhat is two factors that may influence the shape of individuals’ indifference curves (flat or steep) which reflect their preferences for work or leisure? What is the difference between income effect and substitution effect under the basic work-leisure decision model?arrow_forward
- Consider an individual who had been planning to retire in five years. Unfortunately, they've just been laid off and the highest-paying job they've been able to find pays a lower hourly wage than did their previous job. a) Using the concepts of the income and/or substitution effect, describe why we might expect this individual to retire earlier than they originally planned. b) Using the concepts of the income and/or substitution effect, describe why we might expect this individual to retire later than they originally plannedarrow_forwardSuppose that the cost of living increases, thereby reducing the purchasing power of your income. If your money wage doesn’t increase, you may work more hours because of this cost-of-living increase. Is this response predominantly an income effect or a substitution effect? Explain.arrow_forwardQuestion 12. The graph below illustrates the equilibrium outcome of a rising wage. Copy the graph, and indicate the income and substitution effects. Point to the new equilibrium. Explain what makes the new equilibrium optimal for the consumer. What is the total effect of the wage change? Why? 300 IC 225 150 75 8. 10 12 14 18 20 22 24 Hours of free time Consumption (S)arrow_forward
- Say 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_forwardRebecca's wage is $10 per hour, and she can work up to 60 hours per week. The table and the budget constraint graph show the trade-off that she faces between income and leisure in one week of potential work at this wage. Her manager raises her wage to $15 per hour. Change the graph below to illustrate her new income-leisure budget constraint. The line and the individual endpoints are movable. Assume that nothing else changes. Hours Leisure time Income ($) (hours) worked at $10/hour 0 200 400 600 0 20 40 60 60 40 20 0 Income ($) 1000 900 800 700 600 500 400 300 200 100 0 0 10 20 30 40 50 60 70 80 90 Leisure (hours)arrow_forwardSuppose there is an increase in hourly wages. Describe how this change could affect labor supply responses at (i) the extensive margin and (ii) the intensive margin. Note: Try to be as comprehensive as possible with your explanation. Hint: In your explanation, utilize concepts such as "substitution effect" and "income effect." Furthermore, describe how your explanation would depend on whether leisure is assumed to be a normal good versus an inferior good.arrow_forward
- An individual’s labour supply curve is positively sloped when: (2)(1) The substitution effect of a wage increase is positive;(2) The substitution effect is greater than the income effect;(3) The income effect of wage increase is negative;(4) The substitution effect is less than the income effect.arrow_forwardIn the following individual labor supply curve, at which wage is the substitution effect the strongest? Wage ($) 25 20 15 10 S₁ Hours of Work $20 per hour $25 per hour $10 per hour O $15 per hourarrow_forwardConsider the following labor-leisure choice model. Utility function over consumption (C) and leisure (L) U(C.L) = (1/3L1/3 Total hours: H = 40 Labor hours: NS = H - L Non-labor income: π = 30 Lumpsum tax: T = 10 Hourly wage: w = 4 Suppose the hourly wage changes to w = 3. What is the substitution effect of this change on labor supply? A. +2.65 B. -2.65 C. +3.48 D.-3.48 E. None of the abovearrow_forward
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