Question

Sarah is a single mom who can earn $12/hour in the labor market. She has a maximum of 168 hours/week that she can choose to devote to the labor market.Under a government program, Sarahgets a subsidy of 40% of her weekly salary if she earns from $0-$700. If she makes from $701-$900 she can keep the maximum subsidy but does not earn an additional subsidy. For every dollar she earns greater than $900, she loses 70 cents of her subsidy.

a .What would be the change in Sarah’s labor supplied if she originally supplied 5 hours a week to the labor market? What are the income and substitution effects?

b What would be the change in Sarah’s labor supplied if she originally supplied zero hours a week to the labor market? What are the income and substitution effects?

Answer 1

a) If she supplies 5 hours a week, her income increases. Now she is also earning subsidy. As a result of this, demand for leisure increases (income effect, since it is a normal good), suggesting she will work less,. There is no change in price of leisure. So  she is getting more for working less, she will decide to work less.

b) If She orignially supplied zero hours a week, both income and subsitution effect will increase her labor supply. Since wage subsidy is also depended on the percentage of weekly salary. son for the increased propensity to work should be clear from our previous discussion. There is increase the net wage for nonworkers, encouraging Sarah p to join the labor force.