Reference no: EM131004573

In the neo - classical model of labor - leisure choice, the representative consumer receives satisfaction from consumption of goods (C) and from the consumption of Leisure (L). Let C be the composite good with price $1 and L determines the number of hours of leisure this person consumes. Therefore U = f(C,L) for this consumer. This consumer’s consumption is constrained by time and income. Let her non - labor income be V, w be the hourly wage rate and h be the number of hours this consumer allocates to the labor market. Let T hours be the total time available to this consumer per week such that the following equation will hold: T = h+L. This model illustrates the trade - off this consumer faces between labor and leisure. A. Write down the equation of the budget constraint faced by this typical consumer. B. Assume that V remains constant but the hourly wage rate w faced by this consumer increases. Illustrate the impact of this change in w in a graph on the consumer’s budget line. Draw the original and the new budget line with consumption of all the goods C on the y - axis and hours of leisure consumed, L, on the x - axis. Label the y - axis and x - axis intercepts for both the original and the new budget lines. 2 C. Now illustrate in a graph, using budget lines and indifference curves, the income and substitution effects of an increase in the hourly wage rate ‘ w’ on the consumer’s optimal consumption bundle under the following two conditions: (Again assume that the non - labor income V is held constant) a) When the income effect dominates b) When the substitution effect dominates.