Question 1
Suppose a firm is willing to pay an employee $600 per week in total compensation. The worker can either
receive the compensation in wages or health insurance. Assume initially that all compensation received by
workers is subject to a marginal tax of 30%.
a. Placing after tax wages on the vertical axis and the value of health insurance on the horizontal axis,
graph the budget constraint faced by the consumer—what are the possible combinations of after-tax
wages and insurance that the firm can pay the worker that only cost the firm $600 per week? Label this
line segment "a". How much could they spend on health insurance, if they put all of their compensation
into health insurance?
b. Suppose that wages remain taxable but health insurance is now a tax preferred fringe benefit. Graph the
new budget constraint and label it "b". How much could they spend on health insurance, if they put all
of their compensation into health insurance?
c. Suppose that the marginal tax rate increases from 30 to 40%. Graphically illustrate how this alters the
budget constraint from part (b), and label the new line segment "c".