An individual initially earns a wage of $20 per hour and chooses to have 16 hours of free time per day. Their wage then increases to $30 per hour, and they adjust their choice to 17 hours of free time per day. To understand this decision, an economist constructs a hypothetical scenario: if the individual were given a lump-sum payment of unearned income that made them just as well-off as the wage increase, but they still faced the original $20 wage, they would choose 18 hours of free time. Based on this information, what is the change in free time attributable purely to the income effect?
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Decomposition of Effects in Figure E3.4
The Income Effect in Figure E3.4 Results in 8.125 Additional Days of Free Time
An individual initially earns a wage of $20 per hour and chooses to have 16 hours of free time per day. Their wage then increases to $30 per hour, and they adjust their choice to 17 hours of free time per day. To understand this decision, an economist constructs a hypothetical scenario: if the individual were given a lump-sum payment of unearned income that made them just as well-off as the wage increase, but they still faced the original $20 wage, they would choose 18 hours of free time. Based on this information, what is the change in free time attributable purely to the income effect?
When decomposing the impact of a wage increase on an individual's choice of free time, the income effect is measured by finding the change in free time that would result from a hypothetical scenario where the individual faces the new, higher wage rate but is given a lump-sum tax just large enough to return them to their original level of utility.
Isolating the Impact of Purchasing Power
Analyzing a Wage Increase on a Graph
Analyzing the Dominant Income Effect
A worker's hourly wage increases. This change impacts their choice between free time and consumption. Economists break this impact down into two distinct components, which together explain the overall change. Match each economic concept with its correct description in this context.
To isolate the income effect resulting from a wage increase, economists construct a hypothetical scenario. In this scenario, the individual is given a lump-sum payment that allows them to achieve the same utility as they would with the new, higher wage, but they are assumed to be making their choice based on the ______ wage rate.
An economist wants to isolate the pure income effect resulting from a wage increase on an individual's choice of free time. Arrange the following steps in the correct logical order to perform this conceptual analysis.
Evaluating an Economic Explanation
Interpreting a Hypothetical Budget Shift