1. Deby and John are two advisors for a city government. Deby says that since the elasticity of demand for granite countertops is {3 and the elasticity of demand for sinks is {1:5, taxes should be raised entirely from granite countertops. John argues that it is better to levy taxes on both goods anyway. Which advisor should this city government listen to? Why?
2. Suppose that you can earn $20 per hour before taxes, and that you can work up to 2000 hours per year. Consider two systems: (1) no income tax, and (2) an income tax where you pay no tax on the rst $10,000 earned and a tax of 25% on all income over $10,000.
(a) On the same diagram, draw the two annual budget constraint re ecting the consumption-leisure tradeo under the two di erent systems. Label the intercepts, slopes, and kinks if there is any on your graph.
(b) Draw a set of representative indi erence curves such that comparing to the optimal choice under (1), the income e ect of the imposed tax under (2) outweighs the substi-tution e ect.
(c) Draw a set of representative indi erence curves such that comparing to the optimal choice under (1), the substitution e ect of the imposed tax under (2) outweighs the income e ect.
3. The country currently has a tax system that gives each citizen $5; 000 in cash up front, exempts the rst $10; 000 in earned income from tax, taxes all earned income over $10; 000 at a 25% rate. It is considering replacing this system with an EITC-like system. The proposed new system would drop the $5,000 cash give-away, and instead would subsidize the rst $10,000 in earned income at a 50% rate.
All income earned over $10,000 still would be taxed at the same 25% rate.
The EITC bene ts would never be phased out(i.e., regardless of income, everyone quali es for the subsidy for the rst $10; 000 income). Describe the e ects of this policy change on the labor supply of workers with current earned incomes above $10; 000 and below $10; 000.