Question

If for a given individual, between a wage rate of $20 and $25 the ____________________ effect outweighs the ________________ effect, the individual's supply curve of labor curve between those two wages will be _________________.

Answer 1

Substitution Effect outweighs Income Effect ; Labour Supply Curve between wages will be upward sloping. OR :-

Income Effect outweighs Substitution Effect ; Labour Supply Curve between wages will be backward bending

Step-by-step explanation:

Relationship between wage rate & labour supply can be explained by two effects :

• Substitution Effect : Higher wage means more opportunity cost of leisure, so labourer would substitute leisure by working hours. This would imply increased labour supply.
• Income Effect : Higher wage means more income. At higher income, consumer demands more of all goods, including leisure. So that would imply labourer preferring more leisure, decreased labour supply.

Wage rate change from $20 to $25 is a case of wage rate increase

If substitution effect > income effect, labour supply would increase as a result of wage rise ( from $20 to $25). So, the labour supply curve would be upward sloping

If income effect > substitution effect, labour supply would decrease as a result of wage rise ( from $20 to $25). So, the labour supply curve would be backward bending