Question

Suppose the real wage rate w increases from w0 to w1.

Using a graph explain income and substitution effects of an increase in the real wage (similar to the graph we considered when examining the demand). Let leisure be on the x-axis and consumption on the y-axis; an increase in real wage translates to a change in the slope of the budget constraint.

Consider two cases when, as a result, the demand for leisure increases and when the demand for leisure decreases.

Answer #1

sol;

.Initial equilibrium is at
e_{0} . After increase in wage rate new equilibrium is at
e_{1} . L_{0} L_{2} is substitution effect
and L_{2} L_{1} is income effect . Demand for
leisure has increased after rise in wage rate.

Initial eqilibrium is at e_{0} . After increase in wage
rate new eqilibrium is at e_{1} . Substitution effect is
L_{0} L_{2} and income effect is L_{2}
L_{1}. Demand for leisure has decreased after increase in
wage rate.

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Group of answer choices
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