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Labor Supply Theoretical considerations Increasing(or decreasing) taxes changes the after-tax wage rate. Changing the wage rate has two effects Substitution effect -leisure is relatively less costly after the efective wage is cut, so a person substitutes toward leisure and away from work (t leisure) Income effect - The person feels poorer after the effective wage cut, and if leisure is a normal good the person consumes less of it(l leisure)11 Labor Supply: Theoretical Considerations • Increasing (or decreasing) taxes changes the after-tax wage rate. Changing the wage rate has two effects: – Substitution effect – leisure is relatively less costly after the effective wage is cut, so a person substitutes toward leisure and away from work (↑ leisure). – Income effect – The person feels poorer after the effective wage cut, and if leisure is a normal good, the person consumes less of it (↓ leisure)
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