CHAPTER 8: WEALTH AND SUBSTITUTION EFFECTS IN LABOUR AND CAPITAL Flashcards
(19 cards)
Income effects have ______ income
Exogenous
Income arising endogenously from endowments means
Wealth effect
Wealth effects
1) sell leisure in the active market
2) trade assets across time by Saving + borrowing
With endogenous income, income changes as
Price changes as the value of the endowment changes
Substitution effect + wealth efffect point in the
Opposite directions for normal goods and same for interior goods
Value of endowment replaces
I in the budget constraint with p1e1
X1 =
Alpha p1 e1 / p1 = alpha e1
To find the substitution effect we use the
Expenditure minimisation problem
Price increase
Expands the ownser choice set = gets wealthier
For workers, wage is
Like price.
If leisure isn’t quasiliners
Wealth effect
Normal lesisure
Increase wage = increase leisure
Utility maximisation problem for workers + wages
Max u(c,l) subject to c = w(60 - l)
C,l
Wage tax lowers
Workers effective wage
Wage tax causing after tax wage decrease from w to
W(1-t) causes leisure consumption to increase. Decreasing labour, so loafer curve.
With quasilinear leisure this is solely due to substitution effects
For wavers an increase in interest
Substitution encourages saving more
Wealth effect encourages more now
Since both effects pull in different directions, overal savings may increase or decrease.
Borrowers Increase in interest rates,
decreases current consumption
Since substitution + wealth push in the same direction
Future consumption may increase or decrease but present consumption decreases.
Neither a borrower nor a lender:
Change in interest rate
Change in behaviour comes from
No wealth effects.
Substitution efffect, leading to decreases current consumption and some saving
