Toni derives utility from the consumption of leisure (Le) and all other goods (x
ID: 1117337 • Letter: T
Question
Toni derives utility from the consumption of leisure (Le) and all other goods (x). She has non-labor income (Io), must pay p for each unit of x she buys and earns an hourly wage (w) for each hour that she works (La). Toni maximizes her utility subject to her budget constraint and chooses to work 40 hours per week
Suppose the government imposes a tax, t, on each hour worked. Toni now earns w(1-t) per hour. Should we expect the total number of hours she works to increase or decrease? Explain carefully
Explanation / Answer
Taxing will decrease the net wage reveived by toni.
Decrease in wage will have two effect, first tax will make real income of consumer less due to which less leisure is preferred and thus more labor. But simultaneously less wage per hour means relative price of leisure decreases which makes consuner to have more leisure and less labor.
Thus final answer depends on your dominating effect.
If income effect is more then more labor and if substitution effect is more then less labor or less working hours