Question

An employee of a firm has a job where the employee can easily adjust the number of hours they work for the employer per year. The employee is currently payed $40 per hour and will work 2000 hours in 2017. The employer had a good year in 2017 and is considering two changes in the employee’s compensation for 2018.

a) Suppose the employer decides to raise the employees wage to $45 per hour. Explain why it is unclear whether the wage change will cause the employee to choose more or less work in 2018. (Note: The ability of the firm to change wages means this firm is not in a competitive labor market, but this has no impact on the worker’s decision) (1 point)

b) The other alternative the firm is considering is paying the employee a $10,000 bonus, but not changing the wage. Explain how this will change your answer to (a) about how much the employee works in 2018. Explain how it is possible both options cost the employer the same amount of money (1 point)

Answer 1

a) there are two effects on labour-leisure : income effect and substitution effect.

workers choose combinations of hours-worked and income towards the goal of maximizing their level of utility given the time constraint of the number of hours in the day.which can be represented as follows:

maximize U = f(Income, Leisure)
such that
labor hours + leisure hours < total number of waking hours.

since time constarint is not mentaioned it is unclear what impact the wage rise will have on laobour supply.

b)now , if the employer considers paying an employee $10,000 bonus i.e gift in cash , his income increases without any impact on working hours and hence considering leisure as a normal good an individual would want to consume more of it.

now, the lesser hours worked by employee will cost lesser to the employer.so it can be possible that bothnoptions will cost the same amount of money