Consider the representative consumer who decides consumption and leisure. The preference is given by U (C,L) = αln C + (1 −α) ln L. Assume h = 1, i.e., the time endowment is one day. Suppose the non-wage income π −T increases while the wage rate w falls at the same time. The size of the changes can be different. Determine the effects on consumption demand and labour supply (i.e., leisure demand). Use the indifference map to explain your results in terms of income and substitution effects for the following cases: (i) The increase in π −T exactly cancels out the drop in w, i.e., |∆ (π −T)|= |∆w|. (ii) The increase in π −T is greater than the drop in w, i.e., |∆ (π −T)|> |∆w|. (iii) The increase in π −T is smaller than the drop in w, i.e., |∆ (π −T)|< |∆w|.
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Consider the representative consumer who decides consumption and leisure. The preference is given by U (C,L) = αln C + (1 −α) ln L. Assume h = 1, i.e., the time endowment is one day.
Suppose the non-wage income π −T increases while the wage rate w falls at the same time. The size of the changes can be different. Determine the effects on consumption
(i) The increase in π −T exactly cancels out the drop in w, i.e., |∆ (π −T)|= |∆w|.
(ii) The increase in π −T is greater than the drop in w, i.e., |∆ (π −T)|> |∆w|.
(iii) The increase in π −T is smaller than the drop in w, i.e., |∆ (π −T)|< |∆w|.
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