Suppose that the owner of Boyer Construction is feeling the pinch of increased p

Question

Suppose that the owner of Boyer Construction is feeling the pinch of increased premiums associated with workers’ compensation and has decided to cut the wages of its two employees (Albert and Sid) from $25 per hour to $20 per hour. Assume that Albert and Sid view income and leisure as “goods,” that both experience a diminishing rate of marginal substitution between income and leisure, and that the workers have the same before- and after-tax budget constraints at each wage. Albert and Sid's opportunity set is presented below:

a)What is the value of A when the wage is $25?

b)What is the value of A when the wage is $20?

c) At the wage of $25 per hour, both Albert and Sid are observed to consume 14 hours of leisure (and equivalently supply 10 hours of labor). After wages were cut to $20, Albert consumes 11 hours of leisure and Sid consumes 16 hours of leisure. Determine the number of hours of labor each worker supplies at a wage of $20 per hour:

Albert's supply of labor =  

Sid's supply of labor =  

d) How can you explain the seemingly contradictory result that the workers supply a different number of labor hours?

A.Albert has no substitution effect, and Sid has no income effect when the wage declines to $20.

B.Albert has no income effect, and Sid has no substitution effect when the wage declines to $20.

C.Albert's income effect dominates his substitution effect when the wage declines to $20, and vice versa for Sid.

D.Albert's substitution effect dominates his income effect when the wage declines to $20, and vice versa for Sid.

Explanation / Answer

Since the opportunity set of Sid and Albert are not given we can simply multiply the wage rate by the toatl number of hours in a day which is 24 hours . This means that with 0 hours of leisure and 24 hours of work , at a given wage rate , the worker can earn maximum of the below given wages . It is the constraint ( at given wages and all hours of work , not more than the income given below can be earned )

a) Value of A when wage is $25 is given by ($25* 24) = 600 ( since the fgure is not given A is assumed to be the maximum or the cosntraint of the income earned at the given wages by both at the given wage)

b) Value of A when wage is $20 is given by ($20*24)= $480 (since the fgure is not given A is assumed to be the maximum or the cosntraint of the income earned at the given wages by both at the given wage)

c) For determining the number of hours worked at a given wage rate and given the leisure hours, we find it the following way.
As we know that the number of hours in a day is 24 hours . So the total is 24 hours .

Albert at wage rate $20 has 11 hours of leisure , so the number of hours worked is 24-11= 13 hours is the supply of labour hours for Albert.

For Sid's case the number of hours conusmed in leisure is 16 hours , so the number of hours worked is 24-16 = 8 hours. is the supply o0f labour for Sid.

d) The number of hours of labour supply given by the two workers is contradicvtory because the decrease in wage rate is seemed to have two effectsv : the income and substitution effect . The results depend on whether the income effect dominates or the substitute effect.

In case of Albert , it is seen that the number of hours has increased as the income has reduced . this means that he is giving less time to leisure and more time to work . So the income effect is more than the substitution effect as income is being dominant here . By substituting the hours of leisure into work the income earned is being increased. He is giving more importance to income than leisure and has hence reduced the leisure hours .

but if we see the case of Sid , he is consuming more hours of leisure and less of the work as the wage reduces . so this implies that the work is being substituted by leisure . Now that the wage rate has reduced Sid measures or gives less importance to work as for the same work he gets less wage and substitutes it by leisure . So substitution effect is being dominant here.

So the answer is option C Albert's income effect dominates his substitution effect when the wage declines to $20, and vice versa for Sid. because Albert is giving more labour hours and Sid is substituting leisure in place of work ( less labour hours for work )

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