Econ 150a
Labor Economics
Practice test for Ch 1, 2, and 9.
Suggested solutions
1.
Phillip receives EITC. If he earns less than 10,000 per year the government
subsidizes his wages by 40% (or 0.4). If he earns between $10,000 and $12,000
there is no tax. If he earns greater than $12,000 he is taxed 21.06% (or 0.2106).
His market wages are $10 per hour. He has 5,000 hours per year to devote to labor
or leisure. Show all answers from a-e graphically on the same graph.
a. Assuming no subsidy and U(C,L) = CL, find Phillip’s utility maximizing
combination of leisure and labor.
He is maximizing at L=2,500 and H=2,500
b.
Find the maximum value of the subsidy.
Notice 0.4, so if he earns $1, the government subsidizes him by $0.40. If he
earns less than $10,000 he gets $0.40 per dollar earned
1.4*10,000=$14,000 thus if he earns $10,000, he will get a subsidy of
$14,000-$10,000=$4,000
Other accepted answer is $1,270 (from part e)
b.
Find the range of work hours where his wage is $10 and he receives the
full subsidy. (Find the points where no subsidy is earned to the point
where the subsidy is taxed).
Between 1,000 and 1,200
c.
Find the maximum work hours where the subsidy goes to zero.
Total hours are 3,099.34
d.
Now assume he is eligible for the subsidy. Find his utility maximizing
labor and leisure choice.
I've decided to drop this since it won't be on your midterm/final. I don't want
anyone wasting study time on this since it
won't be tested.
e.
On one graph, clearly label all your answers from parts a-d.
Slope = -10
Slope = -7.894
Slope = -10
Slope = -14
4
3
2
1
1 to 2 is H=1000
2 to 3 is H=200
3 to 4 is H=1899
Total hours = 3099
Leisure
30990
16000
14000
Total
income
26270