Question

Consider an individual with $8000 of annual non-labour income. She has total available time of 65 hours per week, for 52 x 65 = 3380 hours per year. Her current wage rate is $13.00 per hour, and she currently chooses to work 1850 hours in a year. i) Draw a labour-leisure diagram, carefully illustrating her current labour supply decision. (4 points) ii) The wage rate decreases to $11.00 per hour, and she decides to work 1800 hours. At $11.00 per hour, if she worked 1700 hours per year, she would have been indifferent to her original work decision in (i). Show her new choice on a diagram, and calculate the income and substitution effects associated with the wage change. (6 points)

Answer 1

51TYA Sot You 260 20 25 1530 3820 Leisure Non-labour income $8000, wage = $13 per have, total available teine3380 ha, (1) Labour income = 13 (3380-1), where I = totod leisure hours - Total income - 8000+ 13 (3380-L) = 8000 +43940-13L = 51940-13L and total expenditure -C, where c = consumption amand and p-price per unit of consumption is ncremalized to 1. → Budget construant is C 8000 +43940-13L oric = 51940-132 The budget constraint is shown ag ABC in fig. 1, with a kink at point B. of oumber of working hours = 1850, labor income - 1850x13 = 240 so → Total consumption - 24050+8000 = 32010 -) The optimal bundle L.C) - (1530,32050), whece 1530 - leisure havu = 3380-1850. tab-supply In fig. 1. the optimal bundle is represented by point E. (i) of wage decreases to $11 рек house, then budget constreant becomes C = 8000 + (3380-L) - C 28000 + 37138-IIL , 16., the budget constraint shitts to ABC as shown in fig.1. The optimal bundle has 1800 hours of work (Gr 3380-1850 - 1580 hours of leisure) > 8000+1800 (W) = 27870 of consumption -) Optimal bundle (L.C) - (1580, 27800), as shown by poort E. The movement from E to E, es la total price ettect. Further, at $11 per hour, if she worked 1700 hauris at leisure = 3380-1700 - 1680 hours), she would have been cordibtercent to here original work decision. This bandle is represented by peiort E2. → Movement from E to E Ge. along the initial inditterence Fig.1 curve substitution et tect -- Substitution eftect = 1850-1700 -150 hours and movement from Esto E, is the income otteet = 1700-1800 when wage falls to $11, laber supply falls from 1850 to 1800 = Price iftect - 1850-1800 -5o. Hence, substitution erteet (15) + income ettect (100) - so (price ebiteet SUOLO 40060 300GD E BIO 10. 2.0cco CIC loot 500 100 ISOD 2010 2500 Jen L