Suppose that a consumer cannot vary hours of work as he or she chooses. In particular, he or she must choose between working q hours and not working at all, where q > 0. Suppose that dividend income is zero, and that the consumer pays a tax T if he or she works, and receives a benefit b when not working, interpreted as an unemployment insurance payment.

(a) If the wage rate increases, how does this affect the consumer’s hours of work? What does this have to say about what we would observe about the behaviour of actual consumers when wages change?

(b) Suppose that the unemployment insurance benefit increases. How will this affect hours of work? Explain the implications of this for unemployment insurance programs.