In figure 2 the budget constraint for t 0 is f gh when

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Unformatted text preview: ve. The point D is at the tangent 2 c = w(1 − t)(h − l) + π − T where t is the tax rate on wage income. In Figure 2, the budget constraint for t = 0, is F GH . When t > 0, the budget constraint is EGH . The slope of the original budget line is: −w; while the slope of the new budget line is: −(1 − t)w. Initially the consumer picks point A on the original budget line. After the tax has been imposed, the consumer picks point B . The point of indifferenceof the imposition line segmentto moveparallel to EG. from point A to point curve, I1, with a of the tax is that is the consumer The pure substitution effect substitutionoriginalinduces the consumer to reduceat the tangent and increase leisure curve I 1, effect indifference curve. Point D is consumption point of indifference D on the (work less). segment that is parallel to EG. The pure substitution effect induces the consumer with a line to reduce consumption and increase leisure (work less). The tax also makes the consumer The tax alsoin that he or she can no longer be on indifference can no longer be on move to the worse off, makes the consumer worse off, in that he or she curve, I 1, but must indifference curve, I1, but must move toThisless preferred indifference curve, I2. Thisto point less preferred indifference curve, I 2. the pure income effect moves the consumer pure income effect moves the consumer to point than point D,less consumption and less and B , which has less consumption and less leisure B, which has because both consumption leisure than point D,goods. The netconsumption tax is to reduce normal goods.but the direction leisure are normal because both effect of the and leisure are consumption, The net effect of net effect to reduce consumption, but the direction of the netin which the substitution of the the tax is on leisure is ambiguous. Figure 2 shows the case effect on leisure is ambiguous. Figure 4.3 shows the case in which the substitution effect on leisurehours worked effect on l...
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