Question

This is Labor Economics Homework

DO ONLY (iii) and (iv). I HAVE DONE (i) and (ii)

Janet's utility depends on consumption c and leisure l. She earns a wage equal to w per hour, has an investment income equal to M $\geq$ 0 and needs to sleep at least 8 hours a night. Normalize the price of consumption goods at $1.

(i) Draw her indifference curves between hours of leisure and consumption, her budget line and her equilibrium choice of c and l. What is the slope of the budget line and what are the intercepts?

(ii) Redo the above in terms of L, labor supply

(iii) Distinguish between income effects and substitution effects of an increase in wage. How does this differ in comparison to the traditional analysis for a good that Janet buys in the market.

(iv) Is the labor supply "upward-sloping" or "backward-bending". Explain in terms of income and substitution effects.

Answer 1

"(iii) Distinguish between income effect and substitution effect of an increase in wage Substitution effect of increase in wage: - As wage increase opportunity cost of enjoying leisure increase and hence labors increase In come effect of increase in wage: - As wage increase labor income increase, and hence leisure increase and labors decrease This income and substitution effect differ from those in product market, where change in police level have effect on demand one demand for goods like If price decrease the purchasing power increase substitution effect increase consumption of good, whose price has faller and consumption of other goods, while income effect increase the consumption of both goods (iv) The individual labor supply curve is ""backward bending^double prime The reason behind this is the people have to two conflicting effect of wage increase and substitution effect when wage rate is small, so that demand for more income or goods and services is very strong, substitution effect is greater than income effect"