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Answers to Selected Questions in Chapters 22 and 23

# Answers to Selected Questions in Chapters 22 and 23 -...

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Answers to Selected Questions in Chapters 22 and 23 Chapter 22 Taxation and Efficiency 4 Craig is willing to work 100 hours for \$40 per hour but will receive only \$24 per hour after tax. The percentage change in labour is ( L / L) = η ( W / W) where W represents wage and η is the ordinary labour supply elasticity. If η = 0.5 and the tax rate is 40%, Craig reduces his labour by 20 hours: (-20/100 = 0.5 × -16/40). Craig now works 80 hours and pays income tax of \$1280 (80 hours × \$16). The total deadweight loss (DWL) is the area between the market wage of \$40 and the compensated labour supply curve (ignoring income effects). Assuming a linear compensated labour supply curve and a perfectly elastic labour demand, the deadweight loss (DWL) of a tax on a labour is given by: DWL = 0.5 (Q 1 – Q 2 )(W 1 –W 2 ) As shown in the text, this is equivalent to DWL = 0.5 Q 1 W 1 η cs t 2 where η cs is the compensated labour supply elasticity and t is the tax rate. Given a compensated labour supply elasticity of 0.7 (which ignores income effects), Craig would reduce his labour by 28 hours.

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