Question

1. Suppose a worker’s non-labour income increases. Use a graph to show the effect on the worker’s labour supply and level of consumption. (Assume that both leisure and consumption are normal goods.)

Answer 1

When the non_labour income increases, the worker will opt for more of leisure than working hours. This will reduce the labour supply. There will be a reduction of working hours.

A worker chooses between consumption and leisure for a given income The indifference curve of the worker shows his preferences. The optimal point is where the indifference curve is tangent to the budget line. Budget line shows the combinations of consumption and leisure that a worker can afford at a given wage rate.

The increase in non_labour income will shift the budget line. The indifference curve will also shift outward and the worker's consumption as well as leisure increases.

Generally, when there is an increase in wage rate the supply of labour increases. This is because more income can be earned by substituting work for leisure. Here ,substitution effect is greater than income effect. Now, when the non_labour income increases, the total income of the worker increased which leads to a shift of budget line. Thus , the income effect is greater than the substitution effect.

As long as the substitution effect is greater than the income effect , the supply curve of labour will be upward. Now, when the income effect is greater than the substitution effect the curve tends to bend backwards.