Question

24. In the labor-leisure choice model, what is the price of leisure?

26. What would be the substitution effect and the income effect of a wage increase?

Answer 1

24.

In The labor-leisure choice model, the price of leisure is the forgone income which could be earned if worked instead of taking leisure.

26.

When the wage rate increases, the income increases by working the same hours and it increases more if working hours increased more.

So with the increase in the wage rate, the income increase, so people like to use more leisure because leisure are a normal good and work is an inferior goods. So with the increase in the income of the consumers, the consumption for the normal good (leisure) increases and work decreases. This is known as the income effect.

Since with the increase in the wage rate, leisure becomes expensive, so people prefer to substitute leisure with work because by taking leisure, it is very expensive. Hence the people like to more at the higher wage rate. This is known as the substitution effect.

So when the substitution effect is more than the income effects, then the labor supply curve is positively sloped but when the substitution effect is less than the income effects, then the labor supply curve is negatively sloped.

Hence the labor supply curve is backward bending curve and vice-versa in case of wage decrease.