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Suppose Bob can earn $10 per hour working at a gas station. He has 12 hours a day available to work, but really prefers spending that time watching the Amazing Race (including re-runs). He also enjoys eating chips, which cost $1 per bag. He has no other income available to him. Bob's utility function is defined by

Where C represents the number of bags of chips and A represents the hours spent watching the Amazing Race.
a) How many hours will Bob choose to work?
b) Suppose the government introduces a 10% income tax as a flat tax. How much more or less will Bob choose to work in response? What is the value of tax revenues collected?
c) Show your results from part (b) in a clearly labelled diagram. describe the separate roles of substitution and income effects related to the introduction of the flat tax. Show the excess burden in the diagram (do not find out excess burden).

Microeconomics, Economics

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