A. What are the two effects of an increase in the wage rate on an individual's labor supply decision? Briefly explain each effect
b. Explain how a labor supply curve could be backward bending.
What will be an ideal response?
a. There are two effects of a wage rate increase: a substitution effect and an income effect. The substitution effect raises the price of leisure, which causes a worker to consume less leisure and supply more labor. Since leisure is a normal good, the income effect leads the worker to choose more leisure and supply less labor.
b. When the wage rate is low, an increase in the wage rate leads to an increase in the quantity of labor supplied because the substitution effect is greater than the income effect. Therefore, the labor supply curve slopes upward. When the wage rate is high, the income effect may be greater than the substitution effect. If this is so, the quantity of labor supplied will decrease as the wage increases and the labor supply curve would be backward bending.
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