Final answer:
In every labor-leisure choice scenario, the labor supply decision is influenced by the income and substitution effects. Which effect dominates is determined by the position of point B in relation to point A on an indifference curve. While the substitution effect pushes for more work and less leisure, the income effect allows for more leisure time at the cost of less work.
Step-by-step explanation:
The subject is concerning the labor supply decision influenced by the income effect and the substitution effect. A wage increase introduces both effects on an individual’s labor supply decision. The substitution effect encourages an individual to work more because earning additional income becomes relatively cheaper compared to leisure. Conversely, the income effect might lead the same individual to work less, opting to enjoy more leisure, as their overall purchasing power increases.
To determine which effect dominates, we must evaluate the individual's utility-maximizing decision at point B, post-wage change. If point B aligns vertically with the original point A, then both effects neutralize each other on leisure. If point B is to the right of point A, the substitution effect is dominant, indicating a preference for income over leisure. If it lies to the left, the income effect surpasses the substitution effect, showing a greater preference for leisure.
Regardless of the direction of the wage change, both effects occur simultaneously, influencing the final decision on labor supply versus leisure preference. This is graphically represented using indifference curves in labor-leisure and intertemporal choices scenarios.