Question

In the labor/leisure model, as wages rise, competing income and substitution effects ultimately determine whether workers supply more or less hours in the labor market. Graph a typical case where workers supply more hours as wages rise. Identify the income and substitution effects. Also explain and show how information from this graph can be used to obtain an individual’s supply curve of labor.

Answer 1

The Indofference Curve benaulys y Coen be used to explown in Onde uddual's choide het ween ancome bind leisure wend to show why highere over time wage rate must be proud a more workers need to worek longer hours Income is Carned by Sacreaticing Come lepure. The greatere the amount of these sherukice of leveure, the Income den individual earns. The Income - Cellurer Candfreauty together with the andorfervence moup besuveen income and lecsurce would determine the metrual Choire by the Indenduell. The Manchum bendent of time a well reebie pere day for the anderaduall ge 24 houres, which he coon ule for worek lind leckune, et To make an Tetbotere onderwidual offere moree houres of worek we have to roure the wage to provide him incentove to foroyo Marie Veikure, This ex depicted in the Rogerce

Foga 1 ->siope=Wlow I slope 6 - LL Lerurce Work

At the equibrulem point E a Speepere leveure - income line EK theon MT has been drawn TL is the hoceres worked not the worge harte w repon represented by the scope of the income-lecture line MT. If the higher overtime wage reato W' represented by the line Ek de romed the en done duas or in caulibreirem as point H on To where he choules to have OL2 leisure time and oMo leemount of income. Thus, he hail Smercekiced LILA morve Tellurce to do overtime worek a Carens Min more chrome than before, He now knows works for Thy houres piere day, Thi bir hourely wage rate wil Twithere, he is better off thein beforep bil he ge now of higher Indifference Curve IC. 2 Income effect and Seebstofletion effect! As an ease of change in pruce, reise in wage reacte has both the leeb &fahretien ound ancome effect. The net combined efreed on the supply of teeb our hours worked) depends on the magna fede of the liebstitution and income bare the rice in wage rearte. The income efreed of the rease in wage rate on Telerce a positive, this ů, leads to the Cherease in hours of leisure enjoyed bend tends to deereale Loeboere

Hp DO luprly, on the other hound, the reare in morge increases the opportunity cost one are of lecture that a 4 makes. by men of leefcere relatively more. popens ine. Theree force, as a result of rede in wage roote individuell fatet lubstitules work fore leisure which leads to the increase in lepply or lelbour a is a substitution erreed of Id the reeke wage role which tends to reduce de cerce wind increase Cueboer w supply o houres worked). It of thies crenere dhood for ein andere dual Seepplekre of. Locbour, cheome ofreet end substHellion e freef worek in opposite directions, Where at whereas income efreed of the reeree on wege reale tends to reeduce supply of lueboure Srebstitution effeef tends to increase it. If the income effect de Stronger then substitution effeet, the net combined effect of reele in wage route will be to reeduce laboure seepdin on the other hound, if selbstitution effeef e relatively lengere theen neomp pfreed, the rise on wage reste woll Chereause telbour Supply, How the effect of rise in wage rate in spiare in to income epreet and Seebstitution effect is shown in Figure 21 РІЧІ

YA MA Income Money 12 Lag 2 T T Zeiture Labour Supply

V In the figure we measure money income on the y axis band lecture from left to reahl eind {vebour Supply Creight to left) the xa oxit suppose to begin with e wage rate as Wo bend ik all the noe voel eble heures OT were elled to do work, omo money income de carened. Thale genel res To on the budget Constreachy are which on the presen! conlfrunt content de uso coelled! Tedeure - income Constrain. It wow be seen from the regeeree that TMO e tangent to Tu belwen teeserie pouth R' This with warge rewete wo the inden dual of is equitabreciem when he enjoys olo redeure ound therefore we of Supplying Tho worek houres of leaboure Now suppose that werge roote reuses to ho with the result theef income- leckere Constructing line rotaries to Tми . Now, w 44 ТМ 1 1 0 new home ledure Construment line the indendeal. ik in equire breuem let pourth of which he lepphes T4 work- heures of labour Which one less then Tho, ahun Thus, with the rease in woogle revete, Seep ply of Labour wees deenemered by Lola To break up the warge eRreet

on herboure supply, we reduce the money oncome by compensating yarevotion in neome To do lo we take away so much income from th anden dual thool he comes back to the origenou Indor fervence Carve TC AB e such Line obtouned after reducing hos money income by Compens netone vere bertion AB tangent to Indifferenke cerve Il out point S bet which he seeppines TL2 houred fore worlk a n This Shoues with change in wage reape from wo to wy, resulting at leasure becoming relatively morex eropensive he liebs ritueles work Lolo for ledere. This des Seeb tiheeton effect which tends to Cherease free boure Seepply by Lola, Now , of the money taken Freom hom de given back to hon so thread the income - ledure whe again Shirts back to TM, With TM₂, we reaches hole old came brulem pos Adon och pour where he supplies T4 work hours, Thus, movement from movement from points point StoH repres ne the income effect of the rice in moge roole sind wis a result the Supply decreases by La Luna Thes, where neome effect of the Cherease in wage reate Causes decrease

in tabouret seepply by Lall the Substitution erreo causes increase in labour seepply by LaLa , It can be been from the figure 2 that in this case theome effed & Streangere theen selbstitution effeef so that the net resuet & reduction in Loeboure supply by Lola worek hours and therefore in this case Leeboer Seeppey cerne bends back whered, now, of Seebstedeton efreed head been. beregen theen income effeet, worek. hores seppured woreld have increased as a reelelf of reese in wage rate bind toeboure seepply Cerere would slope upwared,