Question

2a) Suppose Henley has 320 hours available each month to devote to either labor or leisure. Furthermore, suppose Henley has no nonlabor income and she can earn a wage of $35 per hour. Construct a diagram illustrating Henley's budget constraint (be sure to properly label each axis, identify any intercept values, etc.). (2 points) b) Assume Henley maximizes utility by working 120 hours per month. Label this bundle on the budget constraint above as bundle "A" (be sure to identify the value on each axis). (1 points) c) Now suppose Henley's wage increases to $42 per hour. In the diagram above, illustrate Henley's new budget constraint (be sure to properly label each axis, identify any intercept values, etc.). (2 points) d) Now assume Henley maximizes utility by working 160 hours per month. Label this bundle on the new budget constraint above as bundle "B" (be sure to identify the value on each axis). (1 points) e) In this case, does the substitution or income effect dominate for Henley? (2 points) f) Using the information regarding bundles "A" and "B", construct a diagram (be sure to properly label each axis) and plot two points on Henley's labor supply curve (identify the value on each axis). (3.5 points) g) Using the information regarding bundles "A” and “B”, compute Henley's labor supply elasticity. Is her labor supply elastic or inelastic? (3.5 points)

Answer 1

Graph is below: Labor income 320 x 35 120 x 35 _ IC-1 BC-1 200 320 Leisure b) Point A is labelled above, at the point of tangency of budget line and indifference curve.

Graph is below: Labor income 320 x 42 320 x 35 -.-.-. 160x42 |---- – IC-2 . 120 x 35|--- IC-1 - -.-.-. 160 200 320 Leisure Point B is labelled above Since leisure hours have reduced and work hours have increased with increase in wages, it means substitution effect dominates income effect

Labor supply curve is below: Wage Labour supply 120 160 Labour supplied 8) WO = 35 LO = 120 W1 = 42 L1 = 160 Elasticity = (Change in L/ Change in w) x (wo / LO) Elasticity = (40/7) x (35/120) Elasticity = 1.67