Question

(b) (2.5 points) Suppose that the stock market crashed. Henry’s non-wage income falls and at the same time a reallocation due to family reason lowers his wage rate. More specifically, w = 20 and π = 0. Compute his optimal time allocation and consumption in this case. (c) (1 point) Explain the difference between (a) and (b) using income and substitution effects.

Answer 1

Answer:

0.56

Explanation:

Given,

non-wage income (A) =0

Wage rate (w) = 20

C = w (1-e) + A

20 (1-C/16) + 0

e = C/16

C= 20 - 20c/16

= 80 -5c/4

gc = 80

c = 80/g = 8.89 = 8.9

Hence, e = 8.9/16 = 0.56

As income goes down there will be an increase in leisure at it is a normal good more work.

Price if leisure decrease the wage lost which you would have earned for that hour gone down less work.