Solution to quiz 2

1. (a): a), d)
1. (b): -
1. (c): a), d)
1. (d): c)
2. The tax reduction leads to a positive income shock. As both consumption and leisure are normal goods, this increases the demand for consumption and the demand for leisure, thus a decrease in the labor supply.
3. A subsuitution effect happens when the trade-off between two goods is affected by a change in their relative price. With an income effect the relative price stays put.
4. w represents the price of time (hours of work or hours of leisure) in terms of the consumption good. Or: it is the marginal productivity of labor.
5. While each additional unit of labor increases output, it does so less than the previous one.
Bonus: Nobody is saving, thus nobody would buy the government debt. That is because we have a static model, i.e. that lasts just one period.