Question

1. We expect labor supply to be very inelastic due to opposing income and substitution effects. As a result:
   1. (5 points) Why might the assumption that this tax rate change is Tax revenue neutral be problematic? Would you expect Tax revenue actually to increase or decrease? Why?
   2. (5 points) Based on your analysis in the model, how is the change in income (hint, yes total income does change) distributed across household that depend on labor income vs. household that depend on capital income? (i.e. - whose income is affected more and how (increase or decrease)?)

Answer 1

The wage elasticity of the labor supplies are:

The time is an element that affects the supply: in the short term the labor supply curve would be inelastic since it takes time to
respond to changes in relative wages.

The income effect is the modification in consumption patterns because of a modification in shopping for power.
This occurs with income will increase, value changes, even currency fluctuations. Since income isn't good in itself (it will be exchanged for product and services), falling prices increase buying power.
For instance, a reduction in the price of all cars means that you can buy a cheaper or better car for the same price, thus increasing its utility.

The substitution effect is the variation in consumption patterns due to a change in relative commodity prices.

For instance, if private universities increase their enrollment by 25% and public universities increase their enrollment by 6%, we will probably see a change in

assistance from private to public universities ( among students accepted at both). The same effect applies to all brands, products and even categories of

assets. for example, Coke Vs Pepsi, Birds vs Red Meat, entertainment vs cloths apart from some wage rate, the income effect is greater than the substitution effect, the labor supply curve will go downwards.

The term Neutral Income implies changes in tax laws that do not produce changes in the amount of income that reaches government revenues.

The proposal is neutral in terms of income if it does not increase or decrease tax revenues compared to current law.

More taxes, they stay as long as the tax code exists. Neutral income tax reform implies that government revenues should not be reduced.

A. When the government lowers a marginal tax rate, and that is all it does, this cut has two effects in opposite directions: a substitution effect and an income effect.

The substitution effect is to create leisure more expensive by reducing marginal tax rates increases your real income and, therefore, requires more free time.

The effect of tax cuts. Lower tax rates increase the purchasing power of consumers and can increase aggregate demand, leading to greater economic growth (

possibly inflation). On the supply side, tax cuts can also increase work incentives, leading to higher productivity.

Therefore, the lower the tax rate, the greater the value of all goods and services produced. Government tax revenues do not necessarily increase as the tax rate increases.