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Unformatted text preview: 2010-03-301ECON201Labor SupplyDecompositionInterest rate changeIs it possible for a tax on wages to not affect labor supply?AOGwTAUU1Yes, if income effect and substitution effect exactly equal in magnitudeleisurelBBSubstitution effect (A to B)Income effect (B to C)Tlw(1-t)TCComparing Tax Revenue from Wage Taxto Loss in Well-Being (I)AOGz = pre-tax bundlec = after-tax bundleU1Uzc = tax revenueAssume Labor Supply UnchangedeEVleisureTdfzced = equiv. variationed = zflExcess burden from wage tax= cfLoss in utility exceeds revenuegain to governmentFind loss in well-being (EV):Explanation of Excess Burden of Wage TaxValue of a unit of labor in production = wValue of a unit of labor consumed as leisure = w(1-t)AOGwTleisureTcl1(1-t)wTU1Comparing Tax Revenue from Wage Taxto Loss in Well-Being (II)AOGz = pre-tax bundlec = after-tax bundleUzc = tax revenueU1Assume Labor Supply Increases with TaxeEVleisureTdfed = equiv. variationed = zfzcl1Excess burden from wage tax= cfLoss in utility exceeds revenuegain to governmentalALL WAGE TAXES WILL HAVE AN EXCESS BURDEN.ALL WAGE TAXES WILL HAVE AN EXCESS BURDEN....
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