Tom experiences an increase in his wages.The hours of labor that he supplies to the market would increase if
A) the income effect is larger than the substitution effect.
B) the substitution effect is larger than the income effect.
C) neither the income effect nor the substitution effect apply to Tom's labor-leisure tradeoff.
D) Tom views both labor and leisure as inferior goods.

Question

Quizplus · Accepted Answer

According to the substitution effect, as Tom's wages increase, the opportunity cost of leisure increases, making leisure relatively more expensive than work. As a result, Tom will choose to work more hours to take advantage of the higher wages. This substitution effect dominates the income effect, which suggests that as Tom's wage increases, he can afford to work less and enjoy more leisure time. Therefore, if the substitution effect is larger than the income effect, Tom will choose to work more, leading to an increase in the hours of labor that he supplies to the market.

Tom Experiences an Increase in His Wages