Question

1. Is the United States’ labor supply more inelastic or more elastic? Briefly summarize the competing theories.

2. The demand for energy drinks is more elastic than the demand for milk. Would a tax on energy drinks or a tax on milk have a larger deadweight loss? Explain.

3. You find that your paycheck for the year is higher this year than last. Does that mean that your real income has increased? Explain carefully.

4. For the economy as a whole, how does income compare to expenditures? Explain.

Answer 1

1. In United states people have better standard of living which implies their real income is very high. This also means real wage is also high and there are two concepts on how real wage affects labor supply one is income effect, according to which with higher income people prefer leisure over work which means lower labor supply, the other effect is substitution effect according to which if real wages are high laborers will prefer to work more than have leisure as they find leisure expensive enough to substitute over. Even though the country would try to provide more wages the supply of labor shall remain more or less the same and hence the labor supply is inelastic. Another reason to support the above argument can be that the US society is more advanced in terms of skill and technical knowledge and innovations and these serve as market complexities that is only those can participate who have the required skills no matter how much they raise the income level.

2. Since the demand for energy drinks are elastic that is highly responsive to price changes the any tax on them would increase the dead weight loss which would neither accrue to the producer nor to the consumers and not also as tax revenue to the government. Elasticitiy of supply and demand is an important factor which affect the distribution of taxes between buyer and seller. Elasticity of demand and supply affect the size of deadweight loss caused due to taxation as they determine the quantity exchanged between the parties so higher the demand/supply inelasticity lower shall be the dead weight loss.

3. Higher paycheck implies higher income which is the nominal income that is income in terms of money but that doesn't necessarily mean that the real income that is in terms of baskets of goods one can buy with same amount of money over the period, has also increased. It may so happen that over the year goods and services have become expensive or in other words there is an inflationary trend in the economy  which necessarily has lowered the real income. Although nominal income has risen , goods which the person used to buy has become more expensive too so the person is buying today as much as he was able to buy the previous year before the income had rise.

4. The classical economists believed one man's expenditure is another man's income. In reality they are the two sides of the same coin. For the whole economy income is what the people and government are earning in the form of wages, profits and revenues or fees and they naturally spend what they get as income while the people spend for consumption or investment purposes the government carries out its expenditures by providing public services, defence , law etcetra.