In response to an increase in total factor productivity

Question

Quizplus · Accepted Answer

An increase in total factor productivity increases the wage rate and makes leisure more expensive. This leads to the substitution effect, which suggests that individuals will work more to take advantage of the higher wage rate. However, since income has increased due to higher total factor productivity, the income effect suggests that individuals may choose to work less and enjoy more leisure time. The combined effect is that the substitution effect dominates, leading to an increase in hours worked, but the income effect partially offsets this, leading to a smaller increase in hours worked than would be predicted by the substitution effect alone. Therefore, the correct answer is B.

In Response to an Increase in Total Factor Productivity