Question

use a diagram to show how optimal choice of consumption and leisure changes when an income tax at rate t is introduced.

Answer 1

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Abstract

People do not obtain utility just from products they purchase. They also obtain utility from leisure time. Leisure time is time not spent at work. The decision-making process of a utility-maximizing household applies to what quantity of hours to work in much the same way that it applies to purchases of goods and services. Choices made along the labor-leisure budget constraint, as wages shift, provide the logical underpinning for the labor supply curve. The discussion also offers some insights about the range of possible reactions when people receive higher wages, and specifically about the claim that if people are paid higher wages, they will work a greater quantity of hours—assuming that they have a say in the matter.

Explaination

Figure 1. How a Rise in Wages Alters the Utility-Maximizing Choice. Vivian’s original choice is point O on the lower opportunity set. A rise in her wage causes her opportunity set to swing upward. In response to the increase in wages, Vivian can make a range of different choices available to her: a choice like D, which involves less work; and a choice like B, which involves the same amount of work but more income; or a choice like A, which involves more work and considerably more income. Vivian’s personal preferences will determine which choice she makes.

Main Key Point

• Interpretation labor-leisure budget constraint graphs
• Prediction consumer choices based on wages and other compensation
• Explaination the backward-bending supply curve of labor

Table 11 breaks down the average hourly compensation received by private industry workers, including wages and benefits. Wages and salaries are about three-quarters of total compensation received by workers; the rest is in the form of health insurance, vacation pay, and other benefits. The compensation workers receive differs for many reasons, including experience, education, skill, talent, membership in a labor union, and the presence of discrimination against certain groups in the labor market. Issues surrounding the inequality of incomes in a market-oriented economy are explored in the chapters on Poverty and Economic Inequality and Issues in Labor Markets: Unions, Discrimination, Immigration.

Hours Worked per Week	Number of Workers	Percentage of Workforce
1–14 hours	6.9 million	5.0%
15–34 hours	27.6 million	20.1%
35–40 hours	68.5 million	49.9%
41–48 hours	11.9 million	8.6%
49–59 hours	13.3 million	9.6%
60 hours and over	9.3 million	6.8%

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