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Labor Supply - choose more consumption the effect on the...

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Labor Supply Figure %: Decreased Wages Cause a Pivot in the Budget Constraint The substitution effect and the income effect, which we have seen before in the covering supply and demand , also influence worker's decisions between consumption and leisure. When the wage increases, the income effect makes workers feel wealthier and therefore makes them want more of both leisure and consumption. The substitution effect, however, makes leisure relatively expensive (since the worker would have to give up more wages to have free time; think of the wages lost as the price of leisure), so workers will want more consumption and less leisure. Because labor is inversely related to leisure, this means that an increase in wages will cause labor to both increase (substitution effect) and decrease (income effect). Therefore, when wages increase, the combined effect of the substitution and income effect is that workers will
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Unformatted text preview: choose more consumption; the effect on the level of labor and leisure is uncertain. If we assume that the substitution effect is stronger, then workers will choose to work more and play less, which makes sense, since a higher wage would give workers more incentive to work. Figure %: Income and Substitution Effects on the Consumption/Leisure Decision Is this always true, that the substitution effect outweighs the income effect? Some economists believe that it is initially true, at relatively low wage levels. However, as the wage gets progressively higher, they believe that the income effect begins to outweigh the substitution effect, and very high wage-earners will begin to choose leisure over consumption even if their wage increases. (Maybe that's why corporate bigwigs have the reputation of having too much free time to gallivant around on tropical islands)....
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