If my wage rate increases, utility maximization requires that my quantity of labor supplied

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Quizplus · Accepted Answer

According to the substitution effect, when the wage rate increases, the opportunity cost of leisure increases relative to the cost of work. This causes individuals to substitute away from leisure and towards work, leading them to supply more labor. The income effect, on the other hand, suggests that an increase in wage rate increases the individual's purchasing power, allowing them to afford more leisure at any given level of consumption. However, the income effect only affects the quantity of labor supplied if leisure is a normal good (i.e., an increase in income leads to an increase in demand for leisure). If leisure is an inferior good (i.e., an increase in income leads to a decrease in demand for leisure), the income effect reinforces the substitution effect, leading to an increase in the quantity of labor supplied. Therefore, the combination of the substitution and income effects results in an increase in the quantity of labor supplied when the wage rate increases, which is captured by option D.

If My Wage Rate Increases, Utility Maximization Requires That My