Question

Suppose that Barry's wage increases and he responds by working more hours. Which statement must be TRUE?

	The substitution effect increased hours of work and the income effect increased hours of work.
	The substitution effect of the wage increase caused Barry to substitute leisure for work.
	The income effect of the wage increase dominated the substitution effect of the wage increase.
	Leisure became more expensive, so Barry consumed less of it.

Answer 1

When Barry's wage increases, there are two effects- a) Income effect b) Substitution effect

By income effect, as the wage is increased, people want to enjoy more leisure (less work hour), consider leisure is a normal good.

By substitution effect, the opportunity cost of leisure will be increased so workers will be incentivized to work for longer hours. So labor hour will be increased and leisure will be decreased by substitution effect.

As Barry increases working hour so substitution effect dominates the income effect.

The fourth option is correct