IRE1126

Problem Set 1 – Labour Supply

Distributed: Tuesday, January 21
Due: Thursday, February 6

1. Suppose that Ben has 24 hours in a day at his disposal, and can decide to work for as many or
as few hours as he pleases. Suppose further that he can work at a job that pays $15 per hour.

(a) Draw his budget constraint.

(b) Suppose that he decides to work 8 hours at this wage. Using your graph from part (a), plot an
indifference curve on this diagram that is consistent with the decision to work 8 hours each day,
and be sure to fully label: (i) all of the relevant intercepts, (ii) the coordinates of the key points in
the diagram, and (iii) the choice of hours worked on the diagram.

(c) Now suppose that Ben receives a wage subsidy of $5/hour. Draw his new budget constraint.

(d) Suppose that Ben decides to work for 11 hours after the wage subsidy is in place. Using your
graph from part (c), plot an indifference curve on this diagram that is consistent with the decision
to work 11 hours each day, and be sure to fully label: (i) all of the relevant intercepts, (ii) the
coordinates of the key points in the diagram, (iii) the substitution and income effects, and (iv) the
choice of hours worked on the diagram. (Note that it won’t be possible to provide me with
specific values

2. Suppose that Megan has 24 hours in a day at her disposal, and can decide to work for as many
or as few hours as she pleases. Suppose further that she can work at a job that pays $12 per hour.

(a) Draw her budget constraint.

(b) Suppose that she decides to work 10 hours at this wage. Using your graph from part (a), plot
an indifference curve on this diagram that is consistent with the decision to work 10 hours each
day, and be sure to fully label: (i) all of the relevant intercepts, (ii) the coordinates of the key
points in the diagram, and (iii) the choice of hours worked on the diagram.

(c) Now suppose that Megan receives a demogrant of $60. Draw her new budget constraint.

(d) With her new budget constraint in part (c), show the portions of this budget constraint that
she may and may not move to after receiving the demogrant. Is it possible that Megan will leave
the labour market (and stop working) if she receives this demogrant?
3. Suppose that Molly has 24 hours in a day at her disposal, and can decide to work for as many
or as few hours as she pleases. Suppose further that she can work at a job that pays $8 per hour.

(a) Draw her budget constraint.

(b) Suppose that she decides to work 4 hours at this wage. Using your graph from part (a), plot
an indifference curve on this diagram that is consistent with the decision to work 4 hours each
day, and be sure to fully label: (i) all of the relevant intercepts, (ii) the coordinates of the key
points in the diagram, and (iii) the choice of hours worked on the diagram.

(c) Now suppose that Molly receives a welfare grant of $40. Draw her new budget constraint.

(d) With her new budget constraint in part (c), show how Molly will react (or how she won’t
react) after receiving the welfare grant and provide a brief explanation to accompany your graph.

(e) Suppose that Molly’s welfare benefit fell from $40 to $16. In this case, show how $8/hour
would be Molly’s reservation wage.

4. Suppose that Jen has 24 hours in a day at her disposal, and can decide to work for as many or
as few hours as she pleases. Suppose further that she can work at a job that pays $14 per hour.

(a) Draw her budget constraint, and suppose that she decides to work 6 hours at this wage. Plot
an indifference curve on this diagram that is consistent with the decision to work 6 hours each
day, and be sure to fully label: (i) all of the relevant intercepts, (ii) the coordinates of the key
points in the diagram, and (iii) the choice of hours worked on the diagram.

(b) Now suppose that Jen receives a welfare grant of $30 with an income disregard of $98. Draw
her new budget constraint.

(c) With her new budget constraint in part (b), explain whether or not it would be possible for
Jen to exhaust all of her income disregard.

(d) Now suppose that Jake is offered the same wage of $14 per hour, and chooses to work for 10
hours at this wage rate. If you know that Jake alters his labour supply behaviour after the
establishment of this welfare program with an income disregard, use indifference curves to
demonstrate Jake’s labour supply choices before and after the implementation of this program.