December 20, 2014

Homework Help: microeconomics: work-leisure model

Posted by Victor on Sunday, October 18, 2009 at 3:23am.

Consider the work-leisure model. Assume leisure is a normal good and suppose the wage rate(W) increases, then in this case we will have the following.

Substitution effect: W increases => hours of leisure decrease

Income effect has TWO components:
1. Ordinary income effect: W increases => real income (purchasing power) decreases => hours of leisure decrease
2. Endowment effect: W increases => hours of leisure increase

a) Now I am confused about the two components of the income effect. Can someone please explain why there are two components and what is the difference?

b) Also, in the "ordinary income effect", how come when W increases, the real income/purchasing power DECREASES? This doesn't make sense to me...if W increases, then I have more money, shouldn't my purchasing power INCREASE?

Any help is greatly appreciated!

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