Substitution and Income Effects of the Working Tax Credit on Labour Supply

Labour essay Having considered the implications for the twin towers, we can right off analyse the nominal heads of the policy on savvy supply by determining the substitution and income cause. Its clear that the effect of the wee-weeing(a) evaluate recognize on add behaviour depends upon how much a thespian is currently make believeing. To analyse these effects we pass on only look at one type of respective(prenominal) a lone parent in the promote force. This will simplify our analysis such that we can part the diagram below into 3 sections and describe the effects separately. draw place Figure 1 Diagram showing how the imposition of the twin towers affects the individuals labour supply decision When the lone parent is either not working at all, or working less than 16 minute of arcs (Labelled A in the diagram), her current pursue rate and therefore income is unaffected by the twin towers. This is scarce because they have not yet received any tax credit and therefor e have no added incentives to work. However, if they work everywhere16 hours, the programme will exalt their overall take home occupy as they receive a lump sum payment, shown by the first vertical blue line.Therefore, at this low level of work, there is a very small, or 0, income effect, and a positive substitution effect, thus increasing the individuals labour supply. These effects are the same as would be under an gain in the wage rate, shown diagrammatically in Figure 2. draw couch Figure 2 Diagram showing the effects of a wage increase The drift around the original indifference curve from A to C is the substitution effect this arises due the change in value of leisure relative to hours of work, holding utility as constant.As the wage rate has increased the opportunity cost of leisure opposed to work has risen. The substitution effect encourages the worker to decrease his hours of leisure. The movement from C to B donates the income effect illustrating the workers response to an increase in real income. Overall, the substitution effect dominates the income effect and therefore increases labour supply from L1 to L2. There is also the casualty that the income effect may overpower the substitution effect resulting in a decrease in the supply of labour.However, this depends on the position of the indifference curves, thereof the workers preferences for work and leisure. On the other hand, it is unlikely at this low wage rate for the worker to choose leisure over the opportunity to earn a higher wage. Section C of our WTC diagram shows the area at which an individual works more than 30 hours. The workers net income is now higher at this point, withal the workers marginal wage is lower which is demonstrated by the side of the WTC line being shallower than gradient of the No WTC line.The Substitution and Income effects here are the same as would be with a decrease in wage. Both the Income and substitution effects work unneurotic to reduce the amount of labour shown in Figure 3 drawframe Figure 3 Diagram showing the effects of a wage decrease The substitution effect is shown by the movement around the old indifference curve, from A to C. The income effect is shown by the movement from A to B. Although the substitution effect is stronger, both effects work together to reduce the hours of work from L1 to L3. Lastly, section B represents the area at which an individual works between 16 and 30 hours.Here, the effects of the WTC on labour supply are much more complex. Despite the gradient of the WTC line being the same as section C, this fourth dimension there is the possibility of increasing work to above 30 hours and receiving the supernumerary payment. This therefore results in lone parents bunching around the 16 and 30 hour marks in order to gain the greatest avail from the WTC payment. Some will therefore substitute leisure for work and work longer hours to gain the additional bonus at 30 hours, whilst others will choose to for go work for leisure and be content with the benefit of working over 16 hours.