Question

Assuming consumption and leisure are normal goods, hours worked will fall
when
the wage increase if
A. The income effect dominates the substitution effect.
B. The substitution effect dominates the income effect.
C. The income and substitution effect move in the same direction.
D. The income and substitution effect move in opposite direction
E. The wage increase is accompanied by an increase is accompanied by an increase in
prices
of consumption goods.

Answer 1

When analyzing the effects of a wage increase on hours worked, we consider two main effects: the substitution effect and the income effect.

- The **substitution effect** suggests that as wages increase, working becomes relatively more attractive compared to leisure, leading individuals to work more hours.
- The **income effect** indicates that an increase in wages increases overall income, allowing individuals to consume more goods and leisure, potentially leading them to work fewer hours.

Given that consumption and leisure are both normal goods, if the **income effect dominates the substitution effect**, it would mean that the increase in income from higher wages encourages individuals to take more leisure (work less) because they can afford to do so.

Therefore, the correct answer is:

**A. The income effect dominates the substitution effect.**