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Ira’s only source of income is from working. He can work as many hours per day...

Ira’s only source of income is from working. He can work as many hours per day as he wishes (up to a maximum of 24 hours) at a fixed wage rate of $10 / hour.

b. Suppose, that the government introduces a tax rate of 50 cents in the dollar. Suppose that leisure is a normal good that tax ends up reducing Ira’s hours worked. Show in your diagram the effect of the tax on Ira’s budget constraint and possible indifference curves for his initial and final consumption.

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Answer #1

Suppose, he works h hours a day. He earns 10h, the rest being devoted to Leisure, i.e. 24-h hours for leisure h<=24.
After tax of 50 cents, his earnings would be 9.5h.

At 10h, he consumes more than what he will consume at 9.5h.
Hence,the effect of​ ​​​​​​tax, would be to reduce his working hours to increase Leisure (as he is not getting an adequate return) (SUBSTITUTION EFFECT DOMINATES) (Fig 1). or he may either compensate by working for longer hours (i.e. INCOME EFFECT DOMINATES) (Fig 2)

See Graphs for both attached.

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