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SebKom SebKom
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6 years ago
Other things equal, the less convex is an individual's indifference curve, the greater will be the substitution effect of a wage change.  Explain why.
Textbook 
Modern Labor Economics: Theory and Public Policy

Modern Labor Economics: Theory and Public Policy


Edition: 12th
Authors:
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6 years ago
The substitution effect of a change in the wage is the change in leisure consumption (or hours worked) induced by a change in leisure's opportunity cost while holding utility constant.  An increase in the wage rate other things equal implies that the MRS < W at the original income-leisure combination.  Hence the individual will be compensated for an hour of work by more than is necessary to maintain utility at a given level.  The individual therefore has incentive to work more hours (i.e., substitute income for leisure) as long as MRS < W.  As an individual works more hours, however, the MRS increases because leisure becomes progressively more valuable at the margin as you have less of it.  Substitution of income for leisure therefore will ultimately restore equality between the MRS and the wage.  If an indifference curve is very convex, it won't take much substitution of income for leisure to re-equate the MRS and the wage and the substitution effect will be relatively small. If the indifference curve is not very convex, substitution of income for leisure will move the value of the MRS slowly, hence it will take a lot of substitution of income for leisure to restore equality between the MRS and the wage rate.  Accordingly, the substitution effect (the change in hours worked and leisure consumed) will be comparatively large when the indifference curve is not very convex.
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