Reference no: EM133367646

There are four types of people: 

1. Type 1 (100): Can earn $5 per hour 

2. Type 2 (400): Can earn $10 per hour 

3. Type 3 (400): Can earn $25 per hour 

Type 4 (100): Can earn $100 per hour

Washington B.C. is a city with 1,000 people. 

People who work 40 hours per week. People choose how many weeks they work and can work up to 50 weeks per year. Washington B.C. initially has no tax and transfer programs. 

Suppose Washington levied a 10% income tax ($1 of tax per $10 of income). 

1. How much revenue would Washington collect if workers did not respond to taxes? 

2. Suppose each worker's elasticity of weeks worked with respect to wages was 0.3 (i.e. a 1% increase in wages increases weeks worked by 0.3%). What would be the effect on labor supply of a 10% flat tax? 

3. What would be the effect on workers' total income? 

4. How much revenue would Washington collect?  

5. What would be the effect on the total dollar value of each workers' time (how much would they make if they worked 52 weeks)? 

6. What share of workers' budgets is "spent" on leisure? 

7. One version of the Slutsky relationship is ε u = ε c |{z} substitution effect + ηs |{z} income effect where ε u is the uncompensated Marshallian elasticity, ε c is the compensated substitution-effect Hicksian elasticity, η is the elasticity of labor supply (measured in weeks) with respect to unearned income, and s is the budget share associated with consumption. 

Suppose η = -0.1. (a) Will the substitution effect make workers work more or less in response to taxes? Explain. (b) Will the income effect make workers work more or less in response to taxes? Explain. (c) Based on ε u = 0.3 and η = -0.1, what is your estimate of the compensated elasticity ε c ? (d) What fraction of the effect is explained by substitution? By income? Explain using your answers from a and b.