Question

Explain the economic link between opportunity cost and a decrease in wages. How might this have impacted a workers utility maximizing choice?

Answer 1

Economic link between opportunity cost and decrease in determined by the substitution effect between work and leisure.

At low wages, and low levels of wealth, the substitution effect tends to dominate-people switch from leisure to work in response to the higher opportunity cost of leisure.

Graphically represented, the labor supply curve looks like a backwards-bending curve, where an decline in wages from W3 to W2 will result in more hours being worked and an further decline from from W2 to W1 will result in less..

A rational consumer (decline in wages from W3 to W2) will begin to work more hours to meeting their consumption requirements for utility maximization .(Leisure will go down).