Consider an individual, Terry, who is trying to decide how to allocate 16 hours in her day. (She sleeps the rest of the time.) Terry could earn $40 per hour in the market if she decides to work. She has no nonlabor income.

Use the individual labor supply model to illustrate the individual labor supply decision. Will Terry work in the market at all? How many hours? Upon what does this depend? Fully discuss your model. SHOW a tangency solution with her choosing 8 hours per day.

How would a lump sum subsidy from the government of $40 per day affect Terry's decision? How would a decrease in the income tax of $5 per hour affect her decision? Show these changes in your model and compare them. What are the substitution and income effects in each case?