Role of economic theory In this labor supply case, the after-tax wage changes with the policy Theory predicts that the effect on hours is ambiguous The substitution effect predicts that as the wage(price of leisure)falls, consumers substitute toward leisure The income effect says that if leisure is a normal good consumers consume less of it as income falls Only empirical work-analysis based on observation as opposed to theory -can answer this question 88 Role of economic theory • In this labor supply case, the after-tax wage changes with the policy. – Theory predicts that the effect on hours is ambiguous. – The substitution effect predicts that as the wage (price of leisure) falls, consumers substitute toward leisure. – The income effect says that if leisure is a normal good, consumers consume less of it as income falls. • Only empirical work – analysis based on observation as opposed to theory – can answer this question