With reference to the "Income Effect" on labour supply, consider the following statements: 1. It arises because an increase in wage rate increases the purchasing power of the individual. 2. It encourages the individual to spend more on leisure activities. 3. It always works in the same direction as the substitution effect. Which of the statements given above is/are correct?

Correct Option The correct option is 1 and 2 only. Explanation The supply of labour is determined by the trade-off between work (income) and leisure. When the wage rate changes, it impacts the labour supply through two distinct mechanisms: the Substitution Effect and the Income Effect. Statement-wise Analysis - Statement 1 is Correct: The income effect arises because an increase in the wage rate increases the individual's real income or purchasing power for a given amount of work. The worker feels wealthier because they can earn the same amount of money by working fewer hours or earn more by working the same hours. - Statement 2 is Correct: Leisure is generally considered a "normal good" in economics. As purchasing power rises (due to the income effect), the individual tends to demand more normal goods, including leisure. Consequently, the income effect encourages the individual to consume more leisure (work less) and enjoy their increased wealth. - Statement 3 is Incorrect: The income effect and the substitution effect typically work in opposite directions regarding labour supply: - The Substitution Effect induces an individual to work more as wages rise because the opportunity cost of leisure increases (leisure becomes more expensive). - The Income Effect induces an individual to work less as wages rise because they can afford more leisure. The net effect on labour supply depends on which effect dominates. Key Takeaway Key Takeaway: The Backward Bending Supply Curve of Labour illustrates that at lower wage levels, the substitution effect dominates (labour supply increases with wage), while at higher wage levels, the income effect dominates (labour supply decreases as wages rise further).

NCERT Class 12 Economics — Chapter 2: Market Equilibrium

mcqhard

With reference to the "Income Effect" on labour supply, consider the following statements:

It arises because an increase in wage rate increases the purchasing power of the individual.
It encourages the individual to spend more on leisure activities.
It always works in the same direction as the substitution effect.

Which of the statements given above is/are correct?

Official previous-year question

Verified 1 Aug 2026.

Options

A1 and 3 only
B1 and 2 only
C2 only
D1, 2 and 3

Did you get this right?

Solution

Correct Option

The correct option is 1 and 2 only.

Explanation

The supply of labour is determined by the trade-off between work (income) and leisure. When the wage rate changes, it impacts the labour supply through two distinct mechanisms: the Substitution Effect and the Income Effect.

Statement-wise Analysis

Statement 1 is Correct: The income effect arises because an increase in the wage rate increases the individual's real income or purchasing power for a given amount of work. The worker feels wealthier because they can earn the same amount of money by working fewer hours or earn more by working the same hours.
Statement 2 is Correct: Leisure is generally considered a "normal good" in economics. As purchasing power rises (due to the income effect), the individual tends to demand more normal goods, including leisure. Consequently, the income effect encourages the individual to consume more leisure (work less) and enjoy their increased wealth.
Statement 3 is Incorrect: The income effect and the substitution effect typically work in opposite directions regarding labour supply:
- The Substitution Effect induces an individual to work more as wages rise because the opportunity cost of leisure increases (leisure becomes more expensive).
- The Income Effect induces an individual to work less as wages rise because they can afford more leisure.
The net effect on labour supply depends on which effect dominates.

Key Takeaway

Key Takeaway: The Backward Bending Supply Curve of Labour illustrates that at lower wage levels, the substitution effect dominates (labour supply increases with wage), while at higher wage levels, the income effect dominates (labour supply decreases as wages rise further).

Your note

More from Chapter 2: Market Equilibrium

With reference to the demand for a normal good, consider the following statements: 1. An increase in consumers' income leads to a rightward shift in the market demand curve. 2. An increase in the number of consumers leads to a rightward shift in the market demand curve. 3. A rightward shift in demand, with supply constant, leads to a decrease in equilibrium price. Which of the statements given above is/are correct?

easy

Consider the following statements regarding Market Equilibrium in a perfectly competitive market: 1. An equilibrium is defined as a situation where the plans of all consumers and firms in the market match. 2. In equilibrium, the aggregate quantity that all firms wish to sell equals the quantity that all consumers wish to buy. 3. If the market supply is greater than market demand at a specific price, the market is said to be in a state of excess demand. Which of the statements given above is/are correct?

easy

Consider the following statements regarding the determination of equilibrium with a fixed number of firms: 1. If the prevailing price is lower than the equilibrium price, there will be excess supply in the market. 2. In a situation of excess demand, the market price tends to increase. 3. As price rises, quantity demanded falls and quantity supplied increases, moving the market towards equilibrium. Which of the statements given above is/are correct?

medium

With reference to the Labour Market, consider the following statements: 1. Households are the suppliers of labour, while the demand for labour comes from firms. 2. The demand curve for labour by a profit-maximising firm is upward sloping. 3. The wage rate is determined at the intersection of the demand and supply curves of labour. Which of the statements given above is/are correct?

medium

Consider the following statements regarding the Marginal Revenue Product of Labour (MRPL): 1. It is the extra cost incurred for employing the last unit of labour. 2. It is calculated as the product of Marginal Revenue and Marginal Product of labour. 3. For a perfectly competitive firm, the Marginal Revenue Product of Labour is equal to the Value of Marginal Product of Labour. Which of the statements given above is/are correct?

hard

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Correct Option

The correct option is 1 and 2 only.

Explanation

Statement-wise Analysis

Statement 1 is Correct: The income effect arises because an increase in the wage rate increases the individual's real income or purchasing power for a given amount of work. The worker feels wealthier because they can earn the same amount of money by working fewer hours or earn more by working the same hours.
Statement 2 is Correct: Leisure is generally considered a "normal good" in economics. As purchasing power rises (due to the income effect), the individual tends to demand more normal goods, including leisure. Consequently, the income effect encourages the individual to consume more leisure (work less) and enjoy their increased wealth.
Statement 3 is Incorrect: The income effect and the substitution effect typically work in opposite directions regarding labour supply:
- The Substitution Effect induces an individual to work more as wages rise because the opportunity cost of leisure increases (leisure becomes more expensive).
- The Income Effect induces an individual to work less as wages rise because they can afford more leisure.
The net effect on labour supply depends on which effect dominates.