A firm is willing to pay an employee $600/week in total compensation. The worker can either receive the compensation in wages or health insurance.

a) Suppose that all compensation received by workers is subject to a marginal tax of 30%. Placing health insurance on the vertical axis and all other goods on the horizontal axis, graph the budget constraint faced by the consumer.

b) Suppose that health insurance is now tax-preferred. Graph the new budget constraint.

c) What are the income and substitution effects for health insurance generated by the change in part (b)? Show these on a graph.

d) Suppose that the marginal tax rate decreases from 30% to 15%. What has happened to the relative price of health insurance (assume health insurance is still tax-preferred)? Graphically illustrate how this alters the budget constraint.

e) What are the income and substitution effects for health insurance generated by the tax decrease in part (d)? Show these on a graph.