Lecture 17

Suppose we have two goods consumption and leisure. Suppose the wage goes up and the cost of the first increases, the substitution effect says that the consumption of the latter should decrease. On the other hand, the income effect says that the consumption of the latter should increase since we have more disposable income now.

If the substitution effect is greater than the income effect, they reduce leisure and work more. We must determine which dominates to analyze the situation.