Question

Suppose households supply 600 billion hours of labor per year and have a tax elasticity of supply of 0.15. If the tax rate is increased by 10 percent, by how many hours will the supply of labor decline?

Answer 1

Tax elasticity of labor supply = (%∆ Ls)/(%∆ tax rate)

Given, tax elasticity = 0.15

%∆ tax rate = 10%

Then, %∆ Ls = elasticity * (% ∆ tax rate)

= 0.15 * (10%) = 1.5

Therefore, % ∆ Ls = 1.5%

1.5 % of 600 billion labour hour is = (1.5/100) * 600

= 0.015 * 600 = 9 billion hour

Thus, with increase in tax by 10% will lead to decrease in labour supply by 9 billion hours.