Mid 2016 solution

# Iii an increase in the price of steal will have an

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iii. An increase in the price of steal will have an ambiguous effect on the demand for labor, and therefor an ambiguous effect on wages and employment. If steal and labor are gross complements, then an increase in the price of steal will lead to a decrease in the demand for labor (implying lower wages and lower employment). If steal and labor are gross substitutes, then an increase in the price of steal will lead to an increase in the demand for labor (implying higher wages and higher employment). b. All else equal, the lower is the elasticity of substitution between autoworkers and steal, the lower will be the elasticity of labor demand. Similarly, the lower is the price elasticity of demand for automobiles, the lower will be the elasticity of labor demand. Together, this suggests that an increase in wages will lead to a relatively small drop in employment.

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2. Suppose an individual’s hourly wage is \$12, and they have \$400 per week in non- labor income. Let T denote the number of hours in a week. a. Suppose the government is considering whether to impose a flat tax of \$200 dollars per week on every individual, regardless their labor market earnings. i. (8 points) On the same graph, sketch an individual’s budget constraint before and after the imposition of the flat tax. Be sure to label the x-axis and the y-axis. In addition, for each budget constraint , make sure you label the x -intercept, the y -intercept, the slope and the endowment point. ii. (4 points) What effect will this tax have on people’s hours of work decisions? Carefully explain your answer, discussing both the substitution effect and the income effect. iii. (4 points) What effect is this tax likely to have on the labor force participation rate? Carefully, explain your answer. b. Now, instead of the flat tax, suppose that the government is considering whether to impose a tax of 25 percent on labor market earnings.
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