Question

Suppose a worker is offered a wage of $8 per hour, plus a fixed payment of $100 per day, and he can use 24 hours per day. What is the market rate of substitution between leisure and income? Note from student: I see the answer is 8, but I'm not sure how that is? after calculating total payment of 292, experts have indicated 292/24 = 8, but I get something different (12.16) which is not one of the available options. What am I missing?

Answer 1

Market rate of substitution between leisure and income suggests rate at which the individual is willing to substitute leisure for income. In this case for each additional hour of leisure enjoyed, the individual is willing to lose 1 hour of work. The opportunity cost of this one hour of leisure is therefore, the wage rate lost which is $8. This is irrespective of the fixed payment because the budget line will still have a slope of -w where w is the wage rate.

C = (24 - L)w

wL + C = 24w

Here you can see that the slope of the budget line between income and leisure is -w/1 or -w. This represents the rate of substitution between leisure and income.