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Chapter 17: Problem 1

How can we measure the opportunity cost of leisure? What are the substitution effect and the income effect resulting from a wage change? Why is the supply curve of labor usually upward sloping?

Short Answer

Expert verified
The opportunity cost of leisure refers to the best alternative that's been foregone, usually work. In response to a wage change, the substitution effect signifies a switch from leisure to more work as work becomes more rewarding, while the income effect might oppose this, inducing more leisure because higher income allows for same consumption levels with less work. The labor supply curve slopes upward because higher wages induce people to work more but could backward bend at very high wages, due to the dominating income effect.

Step by step solution

01

Define Opportunity Cost

Opportunity cost is a fundamental concept in economics. It refers to the value of the best alternative forgone, where a choice needs to be made between several mutually exclusive alternatives. In the context of leisure, opportunity cost refers to what is sacrificed when an individual chooses to spend time in leisure activities instead of work.
02

Explain Substitution Effect and Income Effect

The substitution effect is the change in consumption resulting from a change in relative prices, due to a wage change. The income effect on the other hand refers to the change in consumption occasioned by the change in purchasing power from a wage change. Higher wages make leisure more expensive relative to consumption, motivating individuals to substitute leisure with work and this represents the substitution effect. The income effect, however, might motivate more leisure as the higher wage (thus higher income) allows for the same consumption level with less work.
03

Explain why the Labor Supply Curve is Upward Sloping

Lastly, the labor supply curve represents the relation between wages and the quantity of labor supplied, holding other things constant. It slopes upward because as the wage rate rises, people are willing to supply more labor – forgoing leisure time – thereby representing the trade-off between work and leisure. However, at very high wage rates, the income effect could lead to a backward bending labor supply curve.

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