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ProblemSet4-AK

# ProblemSet4-AK - Economics 3203 Fall 2010 Problem Set 4...

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Economics 3203 – Fall 2010 Problem Set # 4: Labor Supply (1) ANSWER KEY 1. The hairdresser could be making a reasonable decision. The income effect encouraged her to consume less leisure (work more) each time she had a wage decrease. However, the substitution effect encouraged her to substitute toward leisure as it got relatively less expensive (work less). When she got her first wage cut, the income effect dominated; when she got her second cut the substitution effect dominated. This creates a backward-bending labor supply curve. 2. C a. 672 U 1 = 6400 128 168 H Expression for Budget Line: C = 4*(168 – H) , or C = 672 – 4 H b. |MRS| = MU H /MU C = C / (H-88) We need to set |MRS| = W, so we have 4 = C / (H-88) Plug in C from budget line: 4 = [4*(168 – H)] / (H-88) Solve: 4H – 352 = 672 – 4H ---> H = 128 hours of leisure is optimal This means C = 4*40 = \$160 and then u = 6400. c

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ProblemSet4-AK - Economics 3203 Fall 2010 Problem Set 4...

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