Question

Show and explain using the individual labor supply model the impact of the following policy changes on the hours worked decision for the typical individual. What substitution and income effects would you predict in each case?

1. Increase in the minimum wage:

2. Decrease in local property taxes

3. Decrease in subsidies for childcare expenses

4. Increase in payroll taxes to replenish the Social Security fund

Answer 1

Increase in the minimum wage rate; here the substitution effect is greater than income effect. If there is rise in minimum wage will retard the workers in the market to prefer more leisure than work. Thus people will substitute more leisure over their work. Workers considered that they will definitely get the minimum wage at higher rate than before. So they will reduce the level of working hours. This will reduce the level of production and growth and again there is a restructuring in the wage rates. Here the substitution effect is greater than the income effect.
Decreasing local property taxes; local property tax is the tax imposed on market value of residential property in the state. This reduction of taxes will increase the level of disposable income and this will help the workers to increase the income effect. Thus people will tried to work more to maintain their consumption level. Without paying the local taxes will help the people to increase their consumption and this will raise the welfare of the people. Here the income effect is greater than the substitution effect.
Decrease in the subsidies for childcare expenses; Most of the companies give subsidies for childcare expenses. If there is a reduction in these subsidies will affect the productivity of workers. Here they will give more preference for childcare. There is substitution over childcare than the working strategy of workers. The substitution effect is greater than the income effect.
Increasing payroll taxes to replenish the social security fund; workers have a high level insurance for the social security in their retirement period. They save for social security funds after their retirement. If the payroll taxes for these funds increased, workers should give a large amount of premium for the funds. This will help the workers to do more works by substituting leisure. Here the income effect is greater than the substitution effect. Workers prefer to do works by increasing the working time because he/she is responsible to protect the time after his retirement.