Answer to Question #87441 in Economics for Frazer Ariki

Question

Use a work leisure diagram that includes non-labour income to portray an Individual who is maximizing utility by working say, 8 hours per day.
Now compare the labour supply effects of imposing (a) a lump sum tax that is the same absolute amount at all levels of income earned; and (b) a proportional tax of say 30 percent on earned income.
A. Use one graph each to illustrate effect of each type of tax on labour supply.
B. Describe the income and substitution effects on hours of work for each tax
C. Do hours of rise or fall in each case?
D. Can you generalize these outcomes for all individuals in the economy? Why or Why not?

Answer 1

A. In both cases labour supply will decrease after the imposing either lump sum or proportional tax.

B. The income effect will be higher for proportional tax and substitution effect will be higher for lump sum tax.

C. Hours of work will fall in both cases, but they will fall more in case of proportional tax.

D. We can't generalize these outcomes for all individuals in the economy, because there may be other factors, that may have significant impact.