Question

Consider the intertemporal model discussed in class and in chapters 11 and 12 of the textbook. Assume that when real wages go up, the substitution effect overwhelms the income effect, resulting in an increase in labor supplied.

Which of the following correctly describes the relationship between real wages and labor supply?

a) Real wages have no effect on labor supply.
b) The income effect dominates the substitution effect.
c) The substitution effect overwhelms the income effect.
d) Real wages decrease labor supplied.

Answer 1

When real wages increase and the substitution effect overwhelms the income effect, labor supply increases, indicating an upward-sloping labor supply curve.

Step-by-step explanation:

The relationship between real wages and labor supply is characterized by both income and substitution effects. When real wages increase, two outcomes are possible: the substitution effect, where individuals choose to work more because the opportunity cost of leisure is higher, and the income effect, where individuals may work less because they can maintain the same standard of living with less work.

The question you've asked relates to a scenario where the substitution effect overwhelms the income effect, leading to an increase in labor supplied. Therefore, the correct answer is (c) The substitution effect overwhelms the income effect. This means that as real wages rise, the increase in labor supply suggests a traditional upward-sloping labor supply curve.