The assumption that current-period labour supply is positively related to the current-period real wage is justified as long as the
A)substitution effect dominates the income effect in the short run.
B)substitution effect equals the income effect in the long run.
C)income effect dominates the substitution effect in the long run.
D)income effect dominates the substitution effect in the short run.
E)substitution effect dominates the income effect in the long run.

Question

Quizplus · Accepted Answer

The assumption that current-period labour supply is positively related to the current-period real wage is justified as long as the substitution effect dominates the income effect in the short run. This is because in the short run, workers may not have the ability to adjust their consumption patterns to fully account for the change in their wages, so they may respond more strongly to changes in the relative attractiveness of working vs. leisure time (the substitution effect). In the long run, workers may be able to make more significant adjustments to their consumption patterns, so the income effect may play a greater role in determining their labour supply response to changes in the real wage.

The Assumption That Current-Period Labour Supply Is Positively Related to the Current-Period