Imagine a consumer with the following budget constraint C = −20l + 60
whereh=24andπ−T =120.
(a) Plot the budget constraint in a (l,C)-diagram, computing the intercepts.
(b) What is the slope of the budget constraint?
(c) Imagine that taxes increased by 10 (consumption goods) and plot the new budget constraint. Draw arbitrary indifference curves (satisfying the usual assumptions) and use these to show how the increase in taxes affects the consumer’s optimal choice and her labor supply curve. Explain your results in terms of income and substitution effects.
(d) Imagine now instead that the wage fell to 10 (consumption goods per hour worked) and plot the new budget constraint. Draw arbitrary indifference curves (satisfying the usual assumptions) and use these to show how the increase in the wage affects the consumer’s optimal choice, and the implications for her labor supply curve. Explain your results in terms of income and substitution effects.