Question

Explain the (i) income effect and (ii) substitution effect of change in wage rate.
Use of diagrams to illustrate your points

Answer 1

Answer:

i) income effects - The income effect is the effect on real income when price changes – it can be positive or negative. In the diagram below, as price falls, and assuming nominal income is constant, the same nominal income can buy more of the good – hence demand for this (and other goods) is likely to rise.

ii) The substitution effect of higher wages means workers will give up leisure to do more hours of work because work has now a higher reward. The income effect of higher wages means workers will reduce the amount of hours they work because they can maintain a target level of income through fewer hours.

Answer 2

Explanation:

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