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mtsolution2011

# mtsolution2011 - MidTerm Exam SOLUTIONS ECON 351 p 1 of 6 1...

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MidTerm Exam SOLUTIONS ECON 351 p 1 of 6

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1. Explain and show graphically the following: a. The effect of an increase in nonlabour income on an individual's reservation wage. (3) Income Slope = -W T Leisure Assuming homothetic preferences (same MRS on ray from origin), then as Y N (nonlabour income) rises, the slope of the indifference curve where it cuts through point Y N , T, becomes steeper, so the reservation wage rises as Y N rises. This makes sense, intuitively. We would expect independently wealthy people to require a higher wage to persuade them to work. b. The labour supply effect of over-time pay of 1.5W for any hours worked past 8 hours, for an individual whose optimum is 8 hours at a wage rate of W. (2) Income T-8 T Leisure Someone who would have worked 8 hours in the absence of over-time would have an over-time slope that is entirely above their indifference curve, therefore this person would have higher utility by choosing to WORK MORE HOURS (the substitution effect will be very large compared to the income effect since the income effect only occurs after 8hours). ECON 351 p 2 of 6 Y N1 Y N2 R' 1 R' 2 R 1 R 2 Slope=-W R2 >W R1 Slope=-W R1 Y N Slope=-(1.5)W E 1 E 2 Slope=-W U 1 U 2 U 1 U 2
c. The labour supply effect of a wage subsidy on an individual who was indifferent between welfare work in the absence of the wage subsidy. (3) Income Slope = -W T Leisure In the absence of the wage subsidy, the budget line is the black line and individual is indifferent between welfare and work (points A and B). Assuming a market wage slightly less than W and this person will not work. With a wage subsidy, the budget line is the grey line. It cuts above the indifference curve in which the individual is indifferent to welfare, thus the wage subsidy will persuade this person to work hours>0 at S. 2.

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mtsolution2011 - MidTerm Exam SOLUTIONS ECON 351 p 1 of 6 1...

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