Quadratic utility, labour supply and the welfare effects of tax changes
This paper examines the use of the quadratic direct utility function in modelling labour supply behaviour. This function has been used in recent empirical studies of labour supply. Emphasis is given to the treatment of welfare changes, involving the derivation of the expenditure function. A convenient expression for the Slutsky condition is also obtained. In examining welfare changes, special attention is given to possible movements to or from corner solutions, since these involve the use of virtual wages rather than observed net wages. In addition, changes in tax parameters can have income and price effects, in view of the endogeneity of the net (or virtual) wage rate and virtual income when faced with piecewise-linear budget constraints. Numerical examples illustrate the effects of tax changes on compensating and equivalent variations.
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Volume (Year): 4 (2000-2001)
Issue (Month): 4 (December)
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