A single mother has y=$400 in non-labor income and w=$15 per hour in labor income. She has up to 100 hours available from which she can decide how much to work. The tax rate is zero.

a) Write down the budget constraint and draw it on a graph. Make sure to label the axes and intercept correctly. Assume that the mother is already working 40 hours per month. Show the indifference curve and the optimal point on the graph. Suppose that there is a fixed cost of $300 per month for childcare that must be paid as soon as the mother starts working.

b) Show how the fixed cost affects the budget line in part (a). Briefly, discuss her likely labor supply response. Use indifference curves on your graph to support your answer. (Hint: leisure is a normal good)

c) Determine the share of substitution and income effects in the total effect

Assume that the government defines a childcare subsidy program such that mothers who are working up to 25 hours per month receive an equivalent of 80 percent of their labor income as childcare support. Those who are working between 25 to 60 hours per month are fully reimbursed. This amount decreases by 50% of the labor income earned for hours beyond 60 until it has been phased out. (Example: If a mother works 61 hours, half of the earned income on the last hour is deducted from the full support. That is, she will receive $292.5 in childcare support.)

d) Define the equation for the subsidy program for all three parts.

Childcare subsidy: 0

25

60

e) Use your answer in part (d) and define the budget constraint after this policy. (Hint: budget constraint for each interval is equal to the corresponding childcare subsidy plus the budget constraint in part (b).)

budget constraint ?? = 0

0

25

60

f) Draw the new budget constraint. Carefully label all the kinked points.

g) Using the consumption-leisure framework, determine the likely response to the childcare subsidy program in terms of hours of work (increase, decrease, no change) and direction of IE and SE if she has already been working for:

i. 10 hours

ii. 40 hours

iii. 70 hours

Put your answers in the given table: