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Labor economics is related to the study of the functioning of the labor markets. The labor markets consist of employers and their workers and their interaction with each other. And the resulting effects of wages and income on the efficiency of this market. Before coming to the policies and theories made to contribute in the efficiency of labor markets, an understanding of the following terms such as Indifference curves, Substitute effect and Income effect should be considered. A brief explanation of these follows:

An indifference curve is represented on a graph that’s horizontal and vertical axes are quantities of goods an individual might consume, an indifference curve represents a contour along which utility for that individual is constant. The indifference curve represents a set of possible consumption bundles between which the individual is indifferent. (Econterms)

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That is, at each point on the curve, the consumer has no preference for one bundle over another. In other words, they are all equally preferred. One can equivalently refer to each point on the indifference curve as rendering the same level of utility (satisfaction) for the consumer.

Consumer theory is a theory of microeconomics that describes the preferences of individuals to consumer demand curve. Every individual has its own preferences and choices, but what matters is that how much the price of the commodity is and whether it is affordable for the individual or not. If the price is low then the person would definitely purchase it and the quantity may be more than required, but if the price is too high then the person would have to think over it to by it or not. And if still the commodity is purchased then it may be in a small quantity. Or the other way out is that he/she would find something else of another price and quality and purchase that good as a substitute to the required one.

The substitution effect is the effect with changes in the relative price of goods. This effect can be used to predict the effect of changes to the budget constraints.

In economics, the income effect is the change in composition resulting from a change in the real income. It is the phenomenon observed through changes in purchasing power. An increase in the income can lead to an increased purchasing power and vice versa.

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