Economists disagree about the magnitude of elasticity of labor supply. The labor market is a key part of the economy. Workers choose how many hours they will work, or even if they are going to take a job at all, depending on the wage they can get. The elasticity of labor supply tells us how much labor supply responds to changes in the wage. Some argue that it is quite low; others say that the elasticity of labor supply is much greater than 1. This debate has important policy consequences. Let's consider what happens when the government imposes a tax on wages, so there is a gap between the wage paid by employers and the wage received by workers. a) Suppose the elasticity of labor supply is very low at the current level of employment. Does this tax have more effect on the wage received by workers, or on the quantity of labor supplied? b) Now suppose the elasticity of labor supply is high at the current level of employment. Does this tax have more of an effect on the wage received by workers, or on the quantity of labor supplied? c) Suppose you are a politician deciding whether to raise revenues by increasing taxes on high income workers. Would you prefer that their supply of labor is elastic or inelastic? Explain.
