A certain individual can choose between work and leisure. She prefers leisure, but if she works, she receives a wage that makes it possible for her to buy things she also wants. In Figure E.10.1, we have illustrated a part of her problem of choosing. Her wage is increased from 20 to 32 and her budget line therefore rotates from BL1 to BL2. We have also drawn two of her indifference curves regarding leisure, LS, and wage, w.
a) Obviously, the individual's utility is increased because of the increase in wage. She also chooses to work more. (She reduces leisure.) To what extent does this depend on the substitution effect and the income effect, respectively?
b) In part a), the individual chose to work more when the wage was increased. It is, however, possible to get the opposite effect, i.e. that she would choose to work less when the wage is increased. Draw an indifference curve in the figure that would have caused the individual to do that. Explain that effect in words. Why does it arise?
c) The effect you studied in part b), does it typically arise for high or for low wages? Alternatively, is it independent of wage?