Question

Suppose you have 24 hours per day that you can allocate between leisure and working. (i)...

Suppose you have 24 hours per day that you can allocate between leisure and working.

(i)

Draw the budget constraint between “leisure hours” on the horizontal axis and “wage income” on the vertical when the wage rate is $40 per hour. Mark an optimum point A that is meaningful. Draw a new budget constraint when the wage rate falls to $30 per hour. Show a new optimum point B.

(ii)

On your indifference curve diagram, decompose the effect of the wage decrease into a “substitution effect” and an “income effect” (What is the direction of the substitution effect, that is, what happens to leisure or work? Assuming leisure is a “normal good”, what is the direction of the income effect?) What can you say about the “net effect” of the wage decrease on your leisure choice? Also provide economic explanations of your decomposition results.
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