2. An individual has 16 hours to be split between leisure (L) and work (H), unearned income (Yn) of $200, and an hourly wage (W) of $30. 8 HOURS WORKING

a) Calculate the following:

Maximum daily income: __$440___________

Slope of the daily budget line if the individual works: ________________

b) Draw the individuals daily budget constraint. Label the axes, intercepts, and kink point.

b) Add a convex indifference curve to your diagram for someone who initially works a positive number of hours but less than 16. Label the point of tangency as 1.

c) Suppose W increases to $35. Add the new budget constraint to your diagram in a different color or as a dotted line, calculate maximum daily income below, then label the new vertical intercept in your diagram

Maximum daily income: __$480___________

d) Add a convex indifference curve to your diagram that is tangent to the new budget constraint. Label that point of tangency as 2.

e) In your diagram, what happened to L as the wage increased?

L: Increased Decreased Stayed the same

f) Decompose the income and substitution effects of the wage increase clearly in your diagram Label the intermediate point as M. For each effect, indicate what points in your diagram illustrate that effect and how that effect causes L to change:

Income effect is movement from _______ to ________ in your diagram

Income effect causes L to: Increase Decrease Stay the same Ambiguous

Substitution effect is movement from _______ to ________ in your diagram

Subst. effect causes L to: Increase Decrease Stay the same Ambiguous

g) Given your answers above, predict what economic theory says will happen to L when W increases to $35.

L will: Increase Decrease Stay the same Ambiguous

h) Given your answer in (e), which effect dominated in your diagram? (substitution, income, or neither?)

i) Consider someone who was initially not working at W = $30. What are that persons income and substitution effects when W increases to $35?

Income effect causes L to: Increase Decrease Stay the same Ambiguous

Subst. effect causes L to: Increase Decrease Stay the same Ambiguous

j) Predict what economic theory says will happen to that persons L when the wage increases:

L will: Increase Decrease Stay the same Ambiguous

k) Explain briefly why your answers in (g) and (j) are different (if they are the same, this is a major clue that you should revisit them).