Question

# Suppose the real wage rate w increases from w0 to w1. Using a graph explain income...

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.

sol;

.Initial equilibrium is at e0 . After increase in wage rate new equilibrium is at e1 . L0 L2 is substitution effect and L2 L1 is income effect . Demand for leisure has increased after rise in wage rate.

Initial eqilibrium is at e0 . After increase in wage rate new eqilibrium is at e1 . Substitution effect is L0 L2 and income effect is L2 L1. Demand for leisure has decreased after increase in wage rate.

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