Ryan experiences an increase in his wages. The hours of labor that he supplies to the market would increase if
A)the income effect is larger than the substitution effect.
B)the substitution effect is larger than the income effect.
C)neither the income effect nor the substitution effect apply to Tom's labor-leisure tradeoff.
D)Ryan views both labor and leisure as inferior goods.

Question

Quizplus · Accepted Answer

According to the substitution effect, as the wage rate goes up, the opportunity cost of leisure time increases, thus incentive to supply more labor increases. However, according to the income effect, as wage rate goes up, the purchasing power of income also increases, thus providing incentives to consume more leisure time. If the substitution effect is larger than the income effect, Ryan would supply more labor because the increase in wages increases the opportunity cost of leisure time more than the increase in purchasing power of income. Therefore, the correct answer is B.

Ryan Experiences an Increase in His Wages