Final answer:
The effect of the Earned Income Tax Credit (EITC) on labor supply for an individual whose EITC benefit is neither increased nor reduced with more work is ambiguous (option b) due to the countervailing forces of the substitution and income effects.
Step-by-step explanation:
Effect of the Earned Income Tax Credit on Labor Supply
For persons who earn an amount of income such that the Earned Income Tax Credit (EITC) benefit is neither increased nor reduced as they work more, the effect of the EITC on labor supply is ambiguous. The EITC incentivizes work by increasing the after-tax wage, which corresponds to the substitution effect, where individuals substitute labor for leisure because the opportunity cost of leisure has increased. However, there is also an income effect, where individuals may choose to work less since they are able to maintain the same standard of living with less work. This dual effect means the net effect on labor supply is uncertain without additional empirical evidence.
The EITC's structure is designed to encourage work among low-income families by offering a tax credit that increases with earned income up to a certain point before it plateaus and eventually phases out. As income reaches the level where the EITC no longer increases with additional work, earning more has two opposing effects: the substitution effect, which would encourage more work because the effective wage rate has increased, and the income effect, which may discourage additional work as the marginal benefit of each additional dollar earned is diminished.
Empirical evidence shows that the EITC has increased labor supply, especially among single mothers. However, at certain income levels where the EITC does not change with increased earnings, it is unclear whether the credit fundamentally changes the supply of labor, since the substitution and income effects counteract each other.