Consider an individual with an annual non-labour income of $10,000 and a wage of $40 per hour. Also assume that this person faces a time constraint: there are only 16 hours available per day to allocate between work and leisure. Draw the annual budget constraint for this individual (on a graph with annual leisure on the horizontal axis and annual consumption on the vertical axis) under the following tax regimes:

1. No tax on personal income

2. A proportional tax on personal income (that is, labour and non-labour income) of 26%

Hint: you are asked to scale everything up to a yearly basis.

a) On the same diagram, draw a set of indifference curves such that the substitution effect generated by the proportional tax dominates the income effect.

b) On a separate diagram, draw a set of indifference curves such that the income effect of the proportional tax dominates the substitution effect.