(c) Now suppose that the government imposes a proportional labour income tax on the consumer's wage income. This is mathematically equivalent to a decrease in the real wage. The slope of the budget line changes from to to u.r {1 t). This rotates the budget line down {counter-clockwise}. Put diEerently, it makes the budget line atter {it is less negative). As a result, consumption drops. De- pending on the relative sizes of the income and substitution effects, leisure could increase or decrease. The e'ect on leisure is ambiguous. In the graph drawn here, the substitution eEect dominates, and leisure increases. If the graph was drawn such that leisure decreases, then the income eEect dominates. (Although it was not asked, let's also consider the effects on the labour supply curve. Relative to a no-tas: case in part (a), the effect on the labour supply is ambiguous. It depends on the relative strengths of the income and substitution eEects. In the picture above, the substitution eEect dominates, implying that introducing the tax will reduce labour supply and shift the labour supply curve 8. (15 points) In questions 1(0) of Exam 1, you investigated the eects of imposing a preportional labour income tax, rather than lumpsum taxes. Suppose that this new scal regime is permanent, i.e., the government makes purchases and collects labour income taxes in all periods. Using the real intertemporal model we developed in class, show graphically how these changes would affect output, employment, real wages, and the real interest rate. (Hint: You should review question 1(c) of Exam 1 to determine how the labour market changes, and you should then determine how desired output demand changes.)