Question

In: Economics

If leisure were an inferior good, how would an individual’s labour supply look like? Explain using...

  1. If leisure were an inferior good, how would an individual’s labour supply look like? Explain using all you know about income and substitution effects and using the income-leisure diagram.

Solutions

Expert Solution

Substitution Effect:-which is the change in quantity demanded resulting from a change in relative price aftercomp[ensating the consumerfor the change in real income

Income Effect:-which is the change in quantity demanded resulting exclusively from a change in real income ,all other prices and money income,

Inferior good:-An inferior good is a type of good whose demand declines when income rises. In other words, demand of inferior goods is inversely related to the income of the consumer. Here leisure is considered as inferior good .In the case of inferiou good income effect is negative and substitution effect always positive.

Income -Leisure choice

Labour supply curve shows the relationship between the supply of labour and wage rate.the labour supply is the choice of income and leisure.Income increases the leisure will be decrease that the income leisure trade off. which is described on the fig A attached to this.Here utility is function of money income and leisure. in the figure X axis shows the leisure and Y axis shows the income. E is the equlibriume point of leisure and income . TheIC curve shows the income leisure trade off curve. In this figure shows the individual optimum combination of income and leisure., at point OPof income and ON hours of leisure . for the particular incomew OP(=EN ) work for NH hours. With the combination of income OP , leisure ON,and Working hours NH,he maximises the utility function for at the point Maximum utility of money equal maximum utility of leisure.

The figure C describe the Derivation of the labour supply curve. that is  Backward-Bending Supply Curve of Labor. The bottom upward-sloping portion of the labor supply curve shows that as wages increase over this range, the quantity of hours worked also increases.In that point the substitution effect,income effect and wage effect are positive. To the middle point nearly vertical portion of the labor supply curve shows that as wages increase over this range, the quantity of hours worked changes very little,due to this there is wage effect and substituion effect are positive but the income effect will be negative .The backward-bending portion of the labor supply curve at the top shows that as wages increase over this range, the quantity of hours worked actually decreases. in that portion wage effect and income effect will be negative however the substitution effect show positive. Through out the supply - leisure choice substitution effect is positive. in this portion substitution effect outweigh the income and wage effect. All three of these possibilities can be derived from how a change in wages causes movement in the labor-leisure budget constraint, and thus different choices by individuals.Simply, this explained the one who achieve their target income , if wage will increase , they do not willing to work more hours they earn leisure spend their leisure time for fulfill their wishes thats why the supply curve bending backward.


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