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    ECON224 Macroeconomics II Problem Set 1

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    ECON224 Macroeconomics II

    Problem Set 1
    Question 1: Chapter 4 - Consumers

    Consider the consumer choice example in chapter 4 (page 137), where consumption and leisure are per-
    fect complements. Assume that the consumer always desires a consumption bundle where the quantities
    of consumption and leisure are equal. Let h = 16.

    (a) Suppose that w = 0.75, π = 0.8, and T = 6. Determine the consumer’s optimal choice of
    consumption and leisure, and show this in a diagram.

    (b) Now suppose that w = 1.5, π = 0.8, and T = 6. Again, determine the consumer’s optimal choice
    of consumption and leisure, and show this in your diagram. Explain how and why the consumer’s optimal
    consumption bundle changes, with reference to income and substitution effects.

    Question 2: Chapter 4 - Consumers

    Suppose, as in the federal income tax code for the United States, that the representative consumer
    faces a wage income tax with a standard deduction. That is, the representative consumer pays no tax on
    wage income for the first x units of real wage income (when w(h − l) ≤ x), and then pays a proportional
    tax t on each unit of real wage income that is greater than x. Assume there is no dividend and lump-sum
    tax.

    (a) Write down the budget constraint for the representative consumer. Graph the budget constraint.

    (b) Now suppose that the government reduces the tax deduction x. Graph the new budget constraint.

    (c) Using the diagrams, determine the effects of reducing the tax deduction x on the consumer, and
    explain your results in terms of income and substitution effects. (Hint: Make sure that you consider two
    cases. In the first case, the consumer does not pay any tax before x is reduced. In the second case, the
    consumer pays a positive tax before x is reduced.

    Question 3: Chapter 4 - Consumers (202223 final exam)

    Consider the consumer’s choice problem in the one-period model.

    The consumer derives utility from both consumption goods c and leisure l. The utility function is
    given as:
    u(c, l) = ln c + a ln l.

    The consumer is endowed with h units of hours. He receives labor income w(h − l). Suppose, as in
    the federal income tax code for the United States, that the consumer faces a wage income tax with a
    standard deduction. That is, the consumer pays no tax on wage income for the first x units of real wage
    income (when w(h − l) ≤ x), and then pays a proportional tax t on each unit of real wage income that
    is greater than x. Assume there is no dividend and lump-sum tax.

    1
    Let a = 1, h = 1, w = 2 and t = 0.1.

    (a) Suppose the government sets the tax deduction x = 0.8. Solve for the optimal consumption bundle
    (optimal consumption and leisure) and total amount of tax paid by the consumer. Explain.

    (b) Now suppose that the government increases the tax deduction x with x = 1.2. Solve for the
    optimal consumption bundle (optimal consumption and leisure) and total amount of tax paid by the
    consumer. Explain.

    (c) Using the diagrams, determine the effects of increasing the tax deduction x on the consumer, and
    explain your results in terms of income and substitution effects.

    Question 4: Chapter 4 - Consumers

    Typically, older workers reduce their hours of work for a period until they retire. How could we
    expalin this in the consumer model in Chapter 4? Draw a diagram and illustrate how this works.

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