Question

Suppose an employee works 42 hours a week for a salary of SEK 8 per hour and that he is taxed at a proportional tax of ten percent. Thus, in a week, this worker earns SEK 336 before and SEK 302.40 after tax. The employee decides for himself how many hours he wants to work per week (no law regulates working hours). Now the income tax is abolished for people who earn less than SEK 1000 per week. In the follow ing three scenarios, explain whether the worker's behavior after the tax change is compatible with economic theory or not. 1. The worker works twice as many hours per week (i.e. 84). ii. The worker works more hours per week, but not twice as many ili. The worker works less than 42 hours a week. iv. The worker continues to work exactly 42 hours a week.

Answer 1

i. If the worker works twice as many hours/week, in that case: In this case his earning will be SEK 672 and since it is less than sek 1000, he will not be taxed which maximises his economic utility and earning. This behaviour is compatible with the economic theory if the worker's level of utility and satisfaction is dependent on his salary and not leisure hours.

ii. The worker works more hours: In this case, again his utility will increase according to pay and will also depend on it if increase in working hours doesnt affect his utility levels.

iii. Less than 42 hours: If he works less than 42 hours, in that case despite increase in leisure hours, his pay will decrease and ultimately reduce his utility

iv. If he works exactly 42 hours, then his utility will increase after tax abolishment.