Discuss how each of the following events affects the number of hours the individual would like...

Discuss how each of the following events affects the number of hours the individual would like to work (increase/decrease/unclear/no change). For full credit, your answer must explain why things change using the terminology of labor supply theory. If the effect is theoretically ambiguous explain why. Depending on the question, you may need to discuss income effects, substitution effects, diminishing returns to income, diminishing returns to leisure and/or the labor/leisure tradeoff. (6 pts)
1. Shogher gets a raise so she makes $25 per hour instead of $20 per hour.
2. Todd inherits $1,000,000. His wage stays unchanged at $40 per hour.
3. Vinitha doesn’t work initially because the best wage offer she has received is $15 per hour and she values her leisure time more than that. One day, she gets a wage offer of $25.

Solutions

Expert Solution

a) Unclear
In this case, the opportunity cost of leisure will increase, therefore incentivising higher working hours due to substitution effect. However, we are not sure about the income effect. If the income effect is positive i.e. the wage increase helps the individual to reach a target level of income, the working hours will increase. However, there exists a possibility that the target income level is achieved by lesser working hours as the wage per hour increases leading to negative income effect. If the overall negative income effect> positive substitution effect, the working hours will decrease.

b) Decrease
Due to the inheritance, worker's preferences will change resulting in the labor valuing leisure at a higher value than before and may substitute leisure for labor.

c) Unclear
Vinitha will only increase the working hours if the new wage offered is greater than the value of her leisure time (which is not given, it can only be inferred that it is greater than 15)

Rahul Sunny answered 1 month ago

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