Assume that the substitution effect dominates the income effect. An increase in both consumption and labor supply would result from
A) a decrease in tax rates.
B) a decrease in transfer payments.
C) an increase in tax rates.
D) an increase in transfer payments.

Question

Quizplus · Accepted Answer

A decrease in tax rates would increase the reward for working, leading people to substitute leisure time for work time. This leads to an increase in labor supply. Additionally, with more disposable income, people would also likely choose to consume more, leading to an increase in consumption.

Assume That the Substitution Effect Dominates the Income Effect