Final answer:
The income effect refers to the change in consumption or spending patterns due to a change in income. In this case, winning a lottery and reducing work hours would result in an increase in leisure time and a decrease in earned income.
Step-by-step explanation:
The income effect is the change in an individual's consumption or spending patterns due to a change in their income. In this scenario, you won a scratch-and-win lottery that will pay you $5,000 per week for the rest of your life. As a result, you have reduced your work hours from 40 hours per week to 10. The income effect in this case would be the increase in your leisure time and the decrease in your earned income from working less.
For example:
Original Choice:
- Leisure: 500 hours
- Work: 2,000 hours
- Income: $16,000 per year
New Choice:
- Leisure: 1,500 hours (500 + 1,000)
- Work: 1,000 hours (2,000 - 1,000)
- Income: $5,000 per year (initial guaranteed income from lottery)
Here, the income effect is the increase in leisure time from 500 hours to 1,500 hours and the decrease in earned income from $16,000 to $5,000 per year.