For this problem set you may work
in groups up to 3 people. Make sure all names are on all pages of the answer sheet. This problem
set is worth 6 points (more than double the 1st problem set). I’ve put some blank graphs on the
last page for you to print out if you need.
1. (3 points) Labor force participation.
Calculate A, B, C, D and E from the table provided (all numbers are in thousands).
Total Percent of
population Number Percent of
2006 228,815 A 66.2 144,427 B C D E
Civilian Labor Force
Not in the
Total labor force Percent of
2. (3 points) Average and marginal tax rates.
Assume the Andrews family earns $250,000 and Jones family earns $400,000 per year in income
and each have no deductions. What is each family’s average and marginal tax rate using the
Marginal tax rates.
450,001 + 39.6%
3. (6 points) Real vs. Nominal. Look up the federal minimum wage for years 1993-2013 (you can
find this many places, including the Bureau of Labor Statistics (BLS)).
Now, assume a single adult worker earned the minimum wage and worked 40 hours a week for
50 weeks a year from January 1, 1993 through December 31, 2013.
(a) Plot, using excel or any other program, annual earnings in each year in both nominal and
real dollars making the base, or reference year 1993.
To create real dollars, use the Consumer Price Index for all Urban Consumers. This is
called the “CPI-U, Consumer Price Indexes for All Urban Consumers, U.S. city average
and selected metropolitan areas.” [Note that in some years the minimum wage change took
place somewhere in the middle of the year. Assume here that the change took place on
January 1st in each year.]
4. (6 points) Labor supply.
(a) (2 points) Assume Jamaal can work up to 60 hours per week at a rate of $10 per hour,
and that because of a government subsidy, Jamaal has $200 in unearned income per week.
Draw Jamaal’s budget constraint showing how much Leisure (L) and Consumption (Y) he
can have. Label both axes with values and titles. Call this Line A. Assume that Jamaal is
a leisure lover and at his preferred bundle he works for 10 hours. Label this point A and
draw an indifference curve for this bundle labeled UA. How much does he earn?
(b) (2 points) Now assume that the cost of child care for Jamaal’s daughter is $100 per week
which he pays only if he works any hours > 0. Re-draw his budget constraint on the same
graph and label it Line B.
What effect will this cost likely have on the amount of labor Jamaal supplies assuming
both consumption and leisure are normal goods? Talk about this in terms of income and
substitution effects. If Jamaal preferred to work 10 hours in the case of no child care costs,
how many hours do you think he will work now?
(c) (2 points) Now assume that Jamaal’s employer is willing to pay $3.33 of Jamaal’s child
care expenses for every hour he works, but only if he works 30 hours or more. Now re-draw
Jamaal’s budget constraint and label it clearly as Line C. Given what you drew for your
previous indifference curves, how do you think this will affect Jamaal’s consumption of
Leisure and Market Goods? Will he work more, less or the same? Explain why.
5. (6 points) EITC.
Assume that the structure of EITC is as follows:
1. During the phase-in range, EITC recipients receive an additional 20% of their income for
each dollar earned up to a maximum of a $2,000 credit.
2. They can earn this $2,000 credit until the phase-out range, which begins when they start
earning $15,000 or more.
3. During the phase-out range, the credit reduces by 10% until it reaches $0.
(a) (2 points) Graph the structure of the EITC with Income on the X-axis and the EITC
credit on the Y-axis. Clearly label all relevant points on the graph, including the maximum
credit, earnings when the credit reaches $0, and earnings at the end of the phase-in range
and at the beginning and end of the phase-out range.
(b) (2 points) Now assume a worker earns $1,000 per-week if she works and can work up to
40 weeks a year. Plot a budget constraint for consumption (Y) on the Y-axis and hours of
Leisure (L) on the X-axis assuming that EITC exists. Now, on the same graph, draw her
budget constraint before EITC legislation was enacted (i.e. if EITC never existed).
Be sure to label on both the Y and X axes the values for each part of EITC. That
is, at how many weeks of work does the phase-in end; what will our worker earn? At how
many weeks of work does the phase-out begin and end; how much does our worker earn at
(c) (2 points) Now assume that this worker was initially working 36 weeks before EITC was
enacted. Draw an indifference curve showing this point and label the curve UN and the
point N. Now draw another indifference curve for the same worker assuming that EITC
legislation has just passed. Label this curve UE and her preferred bundle of Leisure and
Consumption point E. After EITC is passed, do you think she’ll work more, less or the
same? Show this and say why