Question
Use indifference curve/budget constraint diagrams to illustrate the following. [Draw separate diagrams for parts a, b, and c.] Be sure to illustrate (on your diagrams)
Use indifference curve/budget constraint diagrams to illustrate the following. [Draw separate diagrams for parts a, b, and c.] Be sure to illustrate (on your diagrams) both the choice of hours and the income level of the worker after the change in wages or taxes. Provide a brief description of what each diagram shows. Note: When addressing the income and substitution effects, simply discuss them in words; do not illustrate them on the diagrams. a. An individual increases hours of work from 30 to 40 hours following a wage decrease from $15 to $10 per hour. (Assume non-labor income = $200) Is the income or substitution effect dominant in this case? Explain. b. An individual responds to a proportional tax decrease by increasing hours of work from 30 to 40 hours. (Assume the initial wage is $10 and non-labor income is zero. The size of the tax decrease is not specified.) Is the income or substitution effect dominant in this case? Explain. c. Assume the initial wage is $10, non-labor income is $100, and the initial choice of hours is 40 hours per week. How would the individual respond to a lump sum tax decrease of $100? Is the income or substitution effect dominant in this case? Explain.
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