An increase in the real wage
A) represents a pure substitution effect.
B) represents a pure income effect.
C) represents a combination of income and substitution effects.
D) causes a parallel shift in the consumer's budget line.

Question

Quizplus · Accepted Answer

An increase in the real wage can lead to both an income and a substitution effect. The income effect occurs as a result of the new, higher real wage increasing the consumer's purchasing power and thus increasing their demand for all goods. The substitution effect occurs as a result of the higher real wage making leisure relatively more expensive compared to work, thereby inducing the consumer to substitute towards more work and less leisure. Therefore, the increase in real wage represents a combination of income and substitution effects.

An Increase in the Real Wage