Consider a perfectly competitive labor market, with demand and supply curves denoted by D₀ and S₀, respectively. Suppose that market is in an equilibrium with the wage employment denoted as w₀ and E₀. The government introduces a payroll tax of $1 which will be paid by workers. First consider the case where the the demand is upward sloping and the supply is downward sloping (that is, their are neither perfectly elastic nor perfectly inelastic).

Question 4.1 Sketch the a graph of the labor market before the tax is introduced, using D0, L0 and w0, E0 to denote the relevant objects.

Question 4.2 Into the same figure, depict the impact of introduction of taxes, using D1, L1 to denote the labor demand and supply curves, and and w1, E1 to denote the wage that a worker receives and employment in the new equilibrium,

Question 4.3 Show the worker and firm surplus before and after the tax. Show the tax revenue that goes to the government and the deadweight loss.

Question 4.4 Suppose that the demand is perfectly elastic, that is, it is a horizontal line. In a new figure, analyze the impact of payroll taxes paid by workers. Depict worker surplus before and after taxes, and the deadweight loss from taxes. Notice that firm surplus is zero in this case.