Question

For each question state whether the statement in bold is true, false or uncertain. Give a precise and concise justification for your answer. Your justification may include graphs if necessary.

(a) If leisure is normal, the labor supply curve is always “backward bending.”

(b) Sam receives half of his income in wages and half of his income in dividends. He currently takes negligible leisure. Sam would be indifferent between a 5% increase in his wage rate and a 5% increase in his dividend income.

Answer 1

Answer a :-

The above statement is partially correct as if leisure is a normal good an increase in the wage rate will cause backward sloping labour supply curve .

For individuals who are working, the opportunity cost of an additional hour of leisure is the wage rate . individuals choose not to work if the value of leisure time exceeds the market wage .

A change in wage generates :-

1) a substitution effect .

2) income effect

the opportunity cost of leisure time Rises as the wage rate increases. As leisure time becomes more costly ,individuals consume less leisure time and spend more time at work, this is the substitution effect resulting from a higher wage. As the wage rate Rises and individuals real income raises, this lead to an increase in the consumption of normal good. If leisure is a normal good ,the higher wage rate will reduce the individual to consume larger quantity of leisure time and reduce hours of work .This is called income effect resulting from a wage increase .Therefore we conclude that if leisure is a normal good and increase in wage rate will cause the quantity of labour supplied to :-

1) increase when the substitution effect is larger than the income effect.

2) decrease if the income effective larger than the substitution effect.

this is demonstrated in the above supply curve of labour.

Answer b :-

This statement is correct .

In the above figure, we see that the person is earning a non labour income in form of dividend which is dollar 200 and enjoying negligible leisure which is leading to a total income of dollar 400 which means that he is earning $200 of labour income and total of dollar 200 of non labour income. If we divide the dollar 200 labour income by 24 hours of work as he is enjoying negligible leisure his wage rate will become 8.33 dollar per hour .Now in the above figure ,line A to B represents the income line before a 5% increase in non labour income. If is non labour increases by 5% which is equal to $210 in total the income lines will shift from AB to CD ss given in the above figure. When added ,both the incremented non labour income with the labour income we get a total of dollar 410 of income

Now as we have derived in the first part that if his non labour income will be equal to his labour income of dollar 200 then the wage rate would be dollar 8.33 per hour which if increased by 5% will become 8.75 dollar per hour. If we multiply dollar 8.75 into 24 hours of work we get a total of 410 which is when added to non labour income of 200 gives a total income of dollar 410 represented by the blue joint line from point B to D.

Therefore we conclude that if a person is earning 50% of labour income and 50% of dividend income, a 5% rise in wage rate or dividend income will give total effect of same rise in income ,making him indifferent among the two options