Consider your decision about how many hours to work a draw...

Consider your decision about how many hours to work. a. Draw your budget constraint assuming that you pay no taxes on your income. On the same diagram, draw another budget constraint assuming that you pay a 15 percent income tax. b. Show how the tax might lead to more hours of work, fewer hours, or the same number of hours. Explain.

Transcript

00:01 So here we need to think about the choice of hours, right? so let me draw a budget constraint.

00:07 And the choice here is between leisure and earnings, right? so if i don't work at all, presumably i have 24 hours of leisure, but i also have zero earnings.

00:24 Now, if i work 24 hours, and it's, of course, debatable whether that's possible or not, but in principle, i would have 24w, where w would be equal to my wage.

00:35 Right? and that would induce a budget constraint that looks something like this, right? the straight line where the slope is equal to w, right? the slope or minus w.

00:48 Because the idea is that every hour of leisure that you want to buy, you have to give up an hour's worth of the wage.

00:54 So now with tax, right? 24w goes to 24w times 0 .85.

01:08 Well, that's not the, that was a little smush there, times 0 .85.

01:14 Because the idea is if the tax rate is 15%, you only keep 85%.

01:19 So the new one would be right like this.

01:26 Here, this is unaffected by tax, right? because if you are earning zero, the tax doesn't matter to you at all, right? the tax matters in proportion to how much you earn.

01:38 So if you're earning zero, it's not going to affect your choices at all.

01:45 So the way that we think about where a person would choose is to think about their preferences, right, represented by indifference curves.

01:54 So here's this person's original choice of ours, right? where their preferences are chosen so that they've reached the highest possible level of preferences.

02:07 The key thing is here is that there are two effects.

02:11 One is you are poorer...

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