Labor Supply

Will a tax cut induce people to work more? 

This issue can be addressed within the context of a model of labor supply.  In particular, a model of utility maximizing agents facing what is known as the labor-leisure tradeoff is particularly appropriate.  This EconModel application considers both a percentage income tax and a fixed dollar tax or rebate. 

Model LinkLabor Supply,
Income Taxes, and Transfer Payments

<activate the model links>
Printable PDF Exercises

The labor-leisure tradeoff is based on a utility function that depends on two goods, consumption and leisure.  This application analyzes two utility functions:

  • Cobb-Douglas Utility
  • "Real World" Utility

For either utility function, you can draw indifference curves and a budget constraint.  Repeating this process for range of wage rates allows you to:

  • Derive the Supply of Labor
  • Analyze the Effects of Income Taxes
  • Analyze the Effects of Transfer Payments

Under certain conditions, you obtain the famous Backward-Bending Labor Supply Curve that shows labor supplied decreasing as the wage rate increases.