According to supply side economists as tax rates are reduced labour 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 tax reduction raises the after-tax wage and makes working relatively more attractive than leisure, producing a substitution effect that increases labour supply. For labour supply to rise, this substitution effect must exceed the opposing income effect.
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