Question

Suppose a country passes a law that cuts the standard workday from 8 to 7 hours. Overtime (hours worked per day beyond the “standard” workday) in this country is paid at 50% above the normal wage rate. Please answer the following questions related to the work incentives facing workers in this country:

a. Draw the old budget constraint (in leisure/income space), showing the overtime premium after 8 hours of work per day.

b. On your diagram in (a), draw in the new budget constraint.

c. Use your diagrams in (a) and (b) to analyse the change in work incentives facing workers in this country as a result of this new law.

Answer 1

Answer: A and B answer related to below Diagram:

C - Explanation: For those already working overtime, there will be pure income effect reducing overtime hours. For those working between 7 and 8 hours before, there will be a wage increase, producing both income and substitution effects. These effects will tend to work in opposite directions, producing an ambiguous prediction for hours of work (except for those working exactly 7 hours before, for them, the substitution effect dominates and more hours of work will be offered). For those working a bit less than 7 hours before, some will now work overtime (more than 7 hours), others working less than 7 hours may have such steep indifference curves that their labor supply behavior will be unaffected.

-----------------------------------------------------------------------------------------------------------