macro econ hw help

2. Suppose we allow for an income tax 7 on labor income. Assume workers pay for the tax out of their earnings. Thus, instead of earning W/P per hour, they get (1 - 7) W/P in after-tax income. Suppose the government lowers the income tax rate. Show graphically how this would affect labor supply and equilibrium in the labor market. Describe how this would shift the aggregate supply curve? Labor Supply Context: Dividing both sides by P yields the labor supply condition in terms of the real wage W/P W pe P Note the following: a) If workers expect prices to rise (Pe goes up), they will demand higher wages and this will raise the labor supply curve. b) If current prices rise, this decreases the real wage and labor supply curve. c) If the reservation wage (z) rises, then workers will demand higher real wages to work and the labor supply curve will shift up. Labor Demand Context: W (1-a) ZAK" N-a (1 + u) Note how the exogenous variables shift the demand curve: 1) When u goes up, the demand curve shifts in. Recall that u tells us how monopolistic firms are. High values of u mean that firms have significant monopoly power and industries are less competitive. This leads to lower levels of production and lower demand for labor. 2) When the stock of technology (A) rises, workers become more productive. Thus firms are willing to hire more workers at the same real wage, expanding the demand for labor. 3) When the amount of capital (K) in the economy rises, workers again become more productive. By the same logic as with technology, labor demand expands