Question

In: Economics

Draw two qualitative sketches—one showing how a worker’s budget constraint would be affected by a lump-sum...

Draw two qualitative sketches—one showing how a worker’s budget constraint would be affected by a lump-sum payment (such as a Universal Basic Income), the other showing how her budget constraint would be affected by the Earned Income Tax Credit (hint: check section 6.3). Use them to explain how the policies differ in their incentives regarding labor force participation for workers already choosing to work.

b. Draw a second set of sketches identical to the first. Use them to explain how the policies differ in their incentives regarding labor force participation for workers not previously working.

Solutions

Expert Solution

1. Fig A shows the effect of x amount of Universal Basic Income (UBI) lump-sum payment on budget constraint of worker such that even if the worker do not works, it gets to consume x amount of income as X-intercept shifts up by x amount. The Y-intercept of consumption shifts by x amount such that for every level of working hours, income and consumption of worker increases by x amount.

2. Fig B shows the effect of earned income tax credit on the change in shape and slope of budget constraint of a worker since in general earned income tax rate is higher for the lower income-level worker and increases at a decreasing rate with increased income level and becomes nil after certain income level

3. Fig C shows the effect of UBI payment on labour supply with a left-ward shift in ASL curve as worker is able to get x amount as UBI payment even if they do not supply any labour. Moreover, each working labour is able to get same wage rate as earlier even if they work for less hours. Thus, UBI payment will reduce working hours of working labours and increase unemployment rate such that those not working will be incentivized to not seek work and those working will also be incentivized to work less hours.

4. Fig D shows the effect of earned income tax credit on labour supply with a leftward shift of ASL curve due to increased net personal income after tax although increasing at a decreasing rate with increased income level. Hence, the curve slopes downward after increased working hours assuming increased income for each extra working hours. This policy will reduce unemployment rate and will induce those out of work to seek work although the net impact of those working is mixed as for low-income level workers this will induce to work more hours but for higher income level workers this will disincentivize them to work for more hours.


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