If the real interest rate is 2 percent and workers expect real wages to be 4 percent higher next year, according to real business cycle theory, workers will work
A) more this year and less next year.
B) less this year and less next year.
C) more this year and more next year.
D) less this year and more next year.

Question

Quizplus · Accepted Answer

According to real business cycle theory, an increase in expected real wages next year will lead workers to reduce their labor supply this year, as they will be able to consume more with the higher wages they expect to receive next year. Therefore, workers will work less this year (because of the substitution effect), and more next year (because of the income effect). This is consistent with option D, which states that workers will work less this year and more next year.

If the Real Interest Rate Is 2 Percent and Workers