proportional income tax on the representative consumer’s wage income



Assignment 1

Due:  September 25, 2017 (In class)

Question 1 (30 marks)

a)     Suppose that the government imposes a proportional income tax on the representative consumer’s wage income. That is the consumer’s wage income is where t is the tax rate. What effect does the income tax have on consumption and labour supply? Explain your results in terms of income and substitution effects. (7 marks)

b)     Show that the consumer is better off with a lump sum tax than with a proportional tax as wage income (as in part a) given that either tax yields the same revenue for the government. Show this using a diagram and words.

(6 marks)

c)      Suppose that the firm has a minimum quantity of employment, that is the firm can produce no output unless the labour input is greater than or equal to Otherwise the firm produces output according to  Given these circumstances determine the increase of the real wage on the quantity of labour the firm demands. (7 marks)

d)     Derive the firm’s (from part c) demand curve for labour and explain what it represents. (3 marks)

e)     What are three reasons for a competitive equilibrium not being Pareto optimal? What two questions arise from these inefficiencies? (7 marks)

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