People decide how to “budget” their time in much the same way that they decide how to budget for different goods. Each person decides how much they “value” their leisure time versus their work time. The more people work, the more they tend to value their remaining leisure time. This is the justification for paying overtime to people working over 40 hours per week.
(a) How might we model this trade-off economically using the basic labor supply model by showing the budget line and utility curves or indifference curves? In your graph of the basic labor supply, be sure to identify the optimum point of the budget line and the indifference curve.
(b) Suppose that the government imposes a tax on labor. If a tax is imposed on labor, the worker will perceive this tax as a reduction in his or her wage. For every hour worked, the individual worker receives a lower return on his or her labor. Demonstrate the effects of this tax on labor supply using the graph in part a showing a graph of the income effect and the substitution effect. That is, there are two graphs. Summarize the impacts of this tax on labor.