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Chapter 17: Problem 3

Daniel was earning \(\$ 65\) per hour and working 45 hours per week. Then Daniel's wage rose to \(\$ 75\) per hour, and as a result, he now works 40 hours per week. What can we conclude from this information about the income effect and the substitution effect of a wage change for Daniel?

Short Answer

Expert verified
The increase in wage has led to a positive income effect where Daniel’s purchasing power increased since his weekly earnings increased. This implies he can buy more goods and services than before. The substitution effect is also apparent as Daniel chose to work fewer hours, suggesting he substituted his work hours for leisure. The overall effect appears to be dominated by the substitution effect since he chose to reduce his work hours even though his total weekly earnings went up.

Step by step solution

01

Calculate Daniel's weekly earnings before the wage increase

To begin, you need to find out Daniel's earnings from the time he was earning \( $ 65\) an hour. This can be achieved by multiplying his hourly wage by the total number of hours he worked in a week. That is \( $ 65\) per hour * 45 hours = \( $ 2925\) weekly.
02

Calculate Daniel’s weekly earnings after the wage increase

The next step is to find out Daniel’s earnings after his wages increased to \( $ 75\) per hour. This is done by multiplying the new hourly wage by the number of hours he works in a week. That is \( $ 75\) per hour * 40 hours = \( $ 3000\) a week.
03

Analyze the income effect and the substitution effect

Daniel’s weekly earnings increased from \( $ 2925\) to \( $ 3000\), which shows that he can now afford more goods than before even with reduced working hours. This is an example of a positive income effect. However, when his wage rate increased, he also chose to work fewer hours. The higher wage rate made leisure more costly in terms of foregone earnings, prompting Daniel to substitute work for leisure. This illustrates the substitution effect. Also, because he worked fewer hours, it supports the notion that for Daniel, the substitution effect dominated the income effect in this scenario.

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