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This question was created from Econ 2444 Problem Set 2 2018(1) (2).docx


The graph below shows a typical worker's indifference curves and budget constraint. You will analyze the impact of a wage decrease from w to w'.


Market Goods ($) so 11 16 —>- Hours of Nonmarket Time
5 0 <— Hours of Market Time According to the graph above, when wages decrease, labor supply: Circle one:
inceases/decreases/stays the same/cannot tell from the information give. Which effect dominates? Circle one: income effectfsubstitution effect We now want to decompose this change into an income effect and a substitution effect. On the
graph above, draw in a hypothetical budget constraint (parallel to original budget constraint,
tangent to new indifference cure). Label the new tangency, C. On the graph above, show how much of the change between A and B is due to the income effect.
Also, show how much of the change is due to the substitution effect.

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