We have two effects operating in different directions – the substitution effect and the income effect. The substitution effect is where he prefers to work longer hours to obtain a higher income, which allows him to purchase more goods and services. In this scenario, the opportunity cost of leisure, that is the wage he gives up, has increased and he therefore allocates more time to work and less to leisure. The income effect, on the other hand, implies that since he gets paid more per hour than before, his total income has increased (for the same amount of hours) and he might decide to work fewer hours since he prefers to have more leisure.
Between the wage rate and his labour supply (in terms of hours) a positive relationship exists. In other words, as the wage rate increases, his labour supply increases and as the wage rate declines, his labour supply decreases. His supply of labour curve therefore looks as follows:
Indicate whether the following statements is true or false: