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Chapter 19: Problem 10

Greta is an enthusiastic amateur gardener and spends a lot of her free time working in her yard. She also has a demanding and well-paid job as a freelance advertising consultant. Because the advertising business is going through a difficult time, the hourly consulting fee Greta can charge falls. Greta decides to spend more time gardening and less time consulting. Explain her decision in terms of income and substitution effects.

Short Answer

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Question: Explain how the income and substitution effects influence Greta's decision to spend more time gardening and less time consulting. Answer: The income effect influences Greta's decision by suggesting that with a lower consulting fee, she reallocates her time towards leisure activities, like gardening, to maintain her happiness. The substitution effect demonstrates that the decrease in her hourly consulting fee reduces the opportunity cost of leisure (gardening), causing Greta to substitute some of her work hours with leisure hours. Both these effects contribute to Greta's decision to spend more time gardening and less time consulting.

Step by step solution

01

Understand Greta's situation

Greta is an amateur gardener who also works as a freelance advertising consultant. She spends her free time gardening and her work hours consulting. Her hourly consulting fee falls due to difficulties in the advertising industry. We'll now analyze how this price change affects Greta's decision-making between leisure (gardening) and work (consulting).
02

Income effect explanation

The income effect occurs when the decrease in Greta's hourly consulting fee leads to a reduction in her overall income. With a lower income, she might decide to allocate more time to leisure activities, such as gardening, to maintain her overall happiness. Moreover, she may now find it more challenging to purchase gardening-related goods and services, so she chooses to spend more time gardening to compensate for the reduced purchasing power.
03

Substitution effect explanation

The substitution effect arises when the fall in Greta's hourly consulting fee changes the relative price of her work and leisure time. As her hourly consulting fee decreases, the opportunity cost of her leisure time (gardening) decreases as well. Since the relative price of gardening (leisure) decreases compared to consulting (work), Greta substitutes some of her work hours with leisure hours. Therefore, she spends more time gardening and less time consulting.
04

Greta's decision

In conclusion, Greta's decision to spend more time gardening and less time consulting can be explained by both the income and substitution effects. The income effect suggests that with a lower consulting fee, Greta reallocates her time towards leisure activities, like gardening, to maintain her happiness. Simultaneously, the substitution effect demonstrates that, due to the decrease in her hourly consulting fee, the opportunity cost of leisure (gardening) decreases, causing Greta to substitute some of her work hours with leisure hours.

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Most popular questions from this chapter

For each of the following situations in which similar workers are paid different wages, give the most likely explanation for these wage differences. a. Test pilots for new jet aircraft earn higher wages than airline pilots. b. College graduates usually have higher earnings in their first year on the job than workers without college degrees have in their first year on the job. c. Full professors command higher salaries than assistant professors for teaching the same class. d. Unionized workers are generally better paid than non-unionized workers.

In 2013, national income in the United States was \(\$ 14,542.4\) billion. In the same year, 137 million workers were employed, at an average wage, including benefits of \(\$ 64,667\) per worker per year. a. How much compensation of employees was paid in the United States in 2013 ? b. Analyze the factor distribution of income. What percentage of national income was received in the form of compensation to employees in \(2013 ?\) c. Suppose that a huge wave of corporate downsizing leads many terminated employees to open their own businesses. What is the effect on the factor distribution of income? d. Suppose the supply of labor rises due to an increase in the retirement age. What happens to the percentage of national income received in the form of compensation of employees?

Marty's Frozen Yogurt has the production function per day shown in the accompanying table. The equilibrium wage rate for a worker is \(\$ 80\) per day. Each cup of frozen yogurt sells for \(\$ 2\). a. Calculate the marginal product of labor for each worker and the value of the marginal product of labor per worker. b. How many workers should Marty employ?

You are the governor's economic policy adviser. The governor wants to put in place policies that encourage employed people to work more hours at their jobs and that encourage unemployed people to find and take jobs. Assess each of the following policies in terms of reaching that goal. Explain your reasoning in terms of income and substitution effects, and indicate when the impact of the policy may be ambiguous. a. The state income tax rate is lowered, which has the effect of increasing workers' after-tax wage rate. b. The state income tax rate is increased, which has the effect of decreasing workers' after-tax wage rate. c. The state property tax rate is increased, which reduces workers' after-tax income.

Jameel runs a driver education school. The more driving instructors he hires, the more driving lessons he can sell. But because he owns a limited number of training automobiles, each additional driving instructor adds less to Jameel's output of driving lessons. The accompanying table shows Jameel's production function per day. Each driving lesson can be sold at \(\$ 35\) per hour. Determine Jameel's labor demand schedule (his demand schedule for driving instructors) for each of the following daily wage rates for driving instructors: \(\$ 160, \$ 180,\) \(\$ 200, \$ 220, \$ 240,\) and \(\$ 260\)
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