Question

Suppose that the government levies a lump-sum tax on workers. Which of the following best explains the effect on the supply of labor?

A lump-sum tax has only a substitution effect, so increasing the tax will cause the supply of labor to increase.
В. A lump-sum tax has only a substitution effect, so increasing the tax will cause the supply of labor to decrease.
C. A lump-sum tax has only an income effect, so increasing the tax will cause the supply of labor to decrease.
D. A lump-sum tax has both income and substitution effects, so the overall effect on the supply of labor is uncertain.
E. A lump-sum tax has only an income effect, so increasing the tax will cause the supply of labor to increase.

Answer 1

The correct answer is C. A lump-sum tax has only an income effect, so increasing the tax will cause the supply of labor to decrease.

Step-by-step explanation:

The effect of a lump-sum tax on the supply of labor depends on both an income effect and a substitution effect. The income effect occurs when the tax affects the individual's overall income, which can cause a decrease in the supply of labor. The substitution effect occurs when the relative prices of goods and leisure change due to the tax, which can cause an increase in the supply of labor.

In the case of a lump-sum tax, the income effect is typically larger than the substitution effect. This means that increasing the tax will usually cause the supply of labor to decrease. Therefore, option C is the most accurate explanation: A lump-sum tax has only an income effect, so increasing the tax will cause the supply of labor to decrease.