Exhibit 12-1 Along which part of the labor supply curve in Exhibit 12-1 does the income effect of a wage change just equal the substitution effect?

Question

Exhibit 12-1  Along which part of the labor supply curve in Exhibit 12-1 does the income effect of a wage change just equal the substitution effect?

Quizplus · Accepted Answer

The income effect of a wage change is positive, meaning that as wages increase, individuals will have more income to spend and may choose to work fewer hours (the leisure effect). The substitution effect of a wage change is negative, meaning that as wages increase, individuals will choose to work more hours since the opportunity cost of leisure time increases.

Therefore, as the wage increases, the two effects work in opposite directions. At some point, the income effect will just equal the substitution effect, and labor supply will no longer change (the labor supply curve becomes backward bending). This occurs between points b and c in Exhibit 12-1.

Exhibit 12-1 Along Which Part of the Labor Supply