Question

2. Henry works in a movie theater and his wage is initially $12 per hour and he usually works 30 hours per week. Henry’s boss gives him a raise and his wage increases to $15 per hour. Henry now decides to work 33 hours per week.

(a) What is Henry’s labor supply elasticity?

(b) Is Henry’s labor supply curve inelastic or elastic? Explain what this means in a few words.

(c) Explain whether the income or substitution effect dominated after the increase in Henry’s wage.

Answer 1

(a) An increase in Henry's wage from $12 to $15 per hour results in an increase in the number of hours worked frm 30 to 33 per week.

Henry's labour supply elasticity = (3/3)(15/33) = 5/11 or 0.45

(b) Henry's labour supply curve is inelastic (since elasticity<1). This means that an increase in the wage rate per hour does not lead to an increase in the number of hours worked by a large proportion.

(c) Since Henry's number of hours worked increase with an increase in wage rate, hence Henry's income effect dominates the substitution effect.