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Public Economics and Public Finance | Spring 2024

Problem Set 5

Question 1.

An individual can earn $12 per hour if he or she works. Draw the budget constraints that show the monthly consumption–leisure trade-off under the following three welfare programs. Assume  that a person can work at most 24 hours per day times 30 days per month for a total of 720 hours. Make sure to label slopes, intercepts, and kink points.

a) The government guarantees $600 per month in income and reduces the benefit by $1 for each $1 of labor income.

b) The government guarantees $300 per month in income and reduces that benefit by $1 for every $3 of labor income.

c) The government guarantees $900 per month in income and reduces that benefit by $1 for every $2 in labor income, until the benefit reaches $300 per month. After that point, the   government does not reduce the benefit at all.

d) What are the reduction rates (expressed as a percentage) indicated in scenarios A, B, and C?

Question 2.

Senator Ostrich suggests that “in order to end poverty, all we need to do is pay everyone making less than the poverty line the difference between what they are earning and the poverty line.”

Ostrich argues that, based on the set of people currently below the poverty line, this would cost  $98 billion per year. Why is Ostrich understating the costs of this program? Hint: your textbook mentions at least three.

Question 3.

Consider an income guarantee program that is similar to the program discussed in recitation, but instead of an income guarantee of $5,000 and a benefit reduction rate of 40% (Policy A), the income guarantee rises to $8,000 but with a 64% reduction rate (Policy B). Suppose that there are 2,000 possible working hours per year (T=2000) and you earn an hourly wage of $10.

a)  Draw the budget constraint of Policy B.

b)  Which of these two income guarantee programs (A or B) is more likely to discourage work and why?