1. Michael has a total of 400 monthly hours that he can allocate between work and leisure. His utility function is: U(C,L) = C1/2L1/2. This utility function implies that marginal utilities are given by MUL = (1/2)C1/2L?1/2 and MUC = (1/2)C?1/2L1/2. Michael can work any number of hours at a wage of $20. Michael has no non-labour income.

   1. (a) How many hours will Michael choose to work? Illustrate your answer in a graph.

   2. (b) The government introduces a welfare program to help alleviate poverty. Individuals with earnings below $2,500 will receive welfare payments from the government to top-up their income to $2,500. How will the introduction of this welfare program affect Michael’s labour market decisions? Compute mathematically and explain intuitively. Draw a new graph that illustrates the solutions to parts (a) and (b).

   3. (c) The government decides to replace the welfare program with a wage subsidy pro- gram where individuals receive an extra $5 for every hour worked. Show how the new policy affects Michael’s labour market decisions by computing his new choice of working hours. Draw a new graph that jointly illustrates the solutions to parts (a) and (c). Explain intuitively how the wage subsidy impacts Michael’s choices.

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a Michael will choose to work 160 hours This can be calculated by setting the marginal utility of le... View the full answer