A wage increase creates a substitution effect which leads the worker to desire ________ leisure,and an income effect which leads the worker to desire ________ leisure.

Question

Quizplus · Accepted Answer

The substitution effect states that as the wage increases, the opportunity cost of leisure time increases, making leisure time relatively more expensive. Therefore, the worker will substitute leisure time for work time, leading to a decrease in leisure time. On the other hand, the income effect states that as the wage increases, the worker's purchasing power increases, which makes leisure time relatively less expensive. Therefore, the worker will increase their leisure time, since they can now afford it. Overall, the substitution effect and the income effect work in opposite directions, and the income effect dominates the substitution effect only when the good being considered is a normal good. For leisure, it is a normal good, and thus, the income effect leads the worker to desire more leisure time.

A Wage Increase Creates a Substitution Effect Which Leads the Worker