Hint for Question 1 (c): ¡­

Hint for Question 1 (c): Following an increase in wage (relative price of leisure in term of consumption), the expected wealth of the household will also increase. Here, the question asks you to explore the substitution effect of an increase in wage. Hence we need to isolate the effect of a change in the relative price of leisure by keeping the expected wealth constant. We do this by compensating(if wage decreases) or taxing (if wage increases) the household to make the household's expected wealth the same before and after the increase in wage.