Question

6. How would each of the following affect Helena's labour supply decision? Be specific on what happens to her individual labour supply curve. Remember to mention income effect and substitution effect. a) The value of Helena's home triples in an unexpected hot real estate market. b) Originally an unskilled worker, Helena acquires skills that give her access to a higher-paying job. c) A temporary income tax surcharge raises the percentage of her income that she must pay in taxes.

Answer 1

Answer 6:

a. When the value of the home triples, then the overall wealth of the individual in the form of unearned income will incrase. As the level of unearned income of the individual increases, income effect of the increase in wealth will dominate the substitution effect which will induce workers to work for less number of hours and thus reduce individual labor supply of the individual.

b. As the wage rate of Helena increases, the person will be induced to work more because overall income increases with increase in the number of hours worked. Thus, if the substitution effect dominates income effect then individual labor supply curve will increase. However, if income effect dominates substitution effect then individual supply decreases.

c. This will reduce the after tax wage rate of the person. In this case substitution effect will induce the worker to work less because wages have decreased, however, income effect will induce the person to work more to increase overall income. Thus, the ultimate effect on labor supply depends on whether income effect or substitution effect dominates.