Question

If we denote income effect with I and substitution effect with S, for a worker whose wage rate is very high, .

• A. I dominates S
• B. S dominates I
• C. I equals S

Answer 1

The correct option is A I dominates S

Because each hour of work is now better paid, each hour of leisure has become more expensive; there is an incentive to substitute extra work for leisure. On the other hand, with the higher wage, the income is higher. With a higher income, people can buy more goods and services, and want more leisure time. At higher wage rates, the income effect dominates the substitution effect.