Home > Behavioural Economics, Labour Market > Income and Substitution Effects – do they still apply?

Income and Substitution Effects – do they still apply?

fig10-05In most A2 courses income and substitution effects are examined. The textbook identifies each as follows:

Income effect – higher real wages might persuade people to work less hours and enjoy extended leisure time (see graph – SS2).

Substitution effect – people have an incentive to work extra hours because the financial rewards of working are raised, and the opportunity cost of not working has increased (see graph – SS1).

However recent research has shown that since 1980’s the salaries of those in top management jobs has increased whilst those in the middle and lower income bracket have fallen. With inequality rising the higher incomes tend to work more and the lower income less. Furthermore with jobs being more intellectually challenging work has come to offer the sort of pleasures that high income people used to seek in their time off. Leisure is no longer a sign of social power – does it now symbolise people in low skilled jobs and unemployment?

Job satisfaction tends to increase with the prestige of the occupation – “I come to work to relax”. The Economist mentioned a study in 2006 which revealed that Americans with a household income of more than $100,000 indulged in 40% less “passive leisure” (such as watching TV) than those earning less than $20,000. Also the income effect has impacted the lower incomes as technology has allowed them to high-quality and cheap home entertainment.

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