Consider a w

orker/consumer with non

-

labor income, V, of 2 dollars. Time

endowment is T=24, and denote labor supply by h. Suppose the hourly wage is 5, and the

consumption good's price is 1. Suppose that the optimal labor supply (given the

prices) is

h*=8.

a.

(12 pts

.)

Suppose that consumption and leisure are both normal goods and that the

hourly wage rate is now 10. Show carefully in a graph how the change in labor supply

can be decomposed into income and substitution effects

b.

(12 p

ts.)

Suppose that the worker i

s offered the following contract: For every one of

the first 8 hours the wage per hour is 5. If the worker chooses to work for more than 8

hours the wage rate is 10 for each extra hour (above 8). In a new graph depict the budg

et

set. Can you determine how

labor supply changes? (comparing it to the case in which the

wage rate is fixed at 5 dollars per hour).