Question

Consider an indifference curve for someone deciding how to allocate time between work (and thus consumption) and leisure. Suppose the wage increases.

The substitution effect induces you to work and consume _______ in response to higher wages. If consumption is a normal good, the income effect induces you to consume ______ when your wage rises, but if consumption is an inferior good, the income effect induces you to consume ______ in response to higher wages.

True or False: The person’s consumption may fall as a result of the higher wage if consumption is an inferior good.

a. True
b. False

Answer 1

Answer: a) More

b)more

c) less

d) True

Step-by-step explanation:

The substitution effect induces you to work and consume __MORE___ in response to higher wages.

This is because we would like to take advantage of the higher wages. By working more we get paid more and when we are paid more we consume more.

If consumption is a normal good, the income effect induces you to consume ___MORE___ when your wage rises,

This is true because more wages means that we can afford more normal goods so we buy more.

but if consumption is an inferior good, the income effect induces you to consume ___LESS___ in response to higher wages.

Inferior goods are only purchased because we have budget constraints. If more wages come in, we will buy less of inferior goods and more of normal goods.

True.

As just mentioned, inferior goods are only purchased because of a lack of resources (money), if more money came in then the person's consumption of inferior goods is likely to fall in favour of normal goods.