According to supply-side economists, as tax rates are reduced, labor supply should increase. This implies that ?
Correct answer: D. the substitution effect of a wage change is greater than the income effect of a wage change
- A. there is no income effect when tax rates are changed
- B. the income effect of a wage change is greater than the substitution effect of a wage change.
- C. there is no substitution effect when tax rates are changed
- D. the substitution effect of a wage change is greater than the income effect of a wage change
Explanation
A lower tax rate raises the after-tax reward from working, creating a substitution effect toward labor. If labor supply increases, this substitution effect must outweigh the income effect, which may otherwise encourage more leisure.
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