In: Economics
Solution(s):
Since the individual earns a wage of $20/hour and has a total of 100 working hours, that means the total wage of the individual would be = $20 x 100
= $2000
Now, the Aid to Families with Dependent Children (AFDC) program provides $100 at 0 hours pf work but imposes a 25% tax on earned income up to the point where the benefit is paid back. This means the individual will not get any benefit of AFDC, as his income is $2000, and the first tax of 25% collected from him, if he is given AFDC will be $500, i.e. it will cross $100.
Again, the earned income tax credit (EITC) consists of a 50% wage subsidy for the individual working for low hours, up to a maximum additional benefit of $120 and is gradually phased out, also it imposes a 20% tax on individuals who earn more than $500 up to the point where the benefit is paid back. This means, the same individual will also miss this benefit, as 20% of his income ($2000) will be $400 which is way above the subsidy of $120.
Answer (a) :
If we see the graph above, we see that Good A is measured in the X axes and Good B is measured in the Y axes. Here, the curve PQ is the budget constraint. i.e. at his income level of $2000, he will choose OP units of Good B and OQ unit of Good A. Now, if the individual realizes that he can earn $100 free from the Government if his income is NIL (0). The individual also leans that until the amount is paid back his income will be deducted by 25% until it reaches $ 100, i.e. until 400. Now, the individual will think, if he is getting free $100 from the Government if he earns $400 or less, why should be earn more than $400. Therefore, he will be tempted to reduce his work. Here the concept of substitution effect also plays a role. The individual will reduce his per month consumption of Good A and Good B so that he can sustain at $00 or less or substitute Good A and Good B with Good C and Good D, which are cheaper and helps him to sustain somehow, without having to work more.
Answer (b) :
If we see the graph above, we see that Good A is measured in the X axes and Good B is measured in the Y axes. Here, the curve PQ is the budget constraint. i.e. at his income level of $2000, he will choose OP units of Good B and OQ unit of Good A. Now, if the individual realizes that he will earn an additional $120 subsidy from the Government, the individual also leans that until the amount is paid back his income will be deducted by 20% until it reaches $ 500, This will tempt the individual to work more and to increase his work. In the graph we can see that as a result of the subsidy by the Government, the individual now consumes more quantities of both goods A and B and his new budget constraint is RS.
Answer( c) : The same graph GRAPH 1 will also help us to understand how the EITC reduces the interest to work for an individual. When the individual realizes that he is getting a subsidy from the government, the individual will become self-satisfactory and start to consume the new increased quantity of Good A and Good B and be satisfied with what he is consuming and thereby be reluctant to work harder. This will lead to a scenario where in the long run, his net income will reduce and his budget constraint will be lower than the original budget constraint.
Solution(s):
Since the individual earns a wage of $20/hour and has a total of 100 working hours, that means the total wage of the individual would be = $20 x 100
= $2000
Now, the Aid to Families with Dependent Children (AFDC) program provides $100 at 0 hours pf work but imposes a 25% tax on earned income up to the point where the benefit is paid back. This means the individual will not get any benefit of AFDC, as his income is $2000, and the first tax of 25% collected from him, if he is given AFDC will be $500, i.e. it will cross $100.
Again, the earned income tax credit (EITC) consists of a 50% wage subsidy for the individual working for low hours, up to a maximum additional benefit of $120 and is gradually phased out, also it imposes a 20% tax on individuals who earn more than $500 up to the point where the benefit is paid back. This means, the same individual will also miss this benefit, as 20% of his income ($2000) will be $400 which is way above the subsidy of $120.
Answer (a) :
If we see the graph above, we see that Good A is measured in the X axes and Good B is measured in the Y axes. Here, the curve PQ is the budget constraint. i.e. at his income level of $2000, he will choose OP units of Good B and OQ unit of Good A. Now, if the individual realizes that he can earn $100 free from the Government if his income is NIL (0). The individual also leans that until the amount is paid back his income will be deducted by 25% until it reaches $ 100, i.e. until 400. Now, the individual will think, if he is getting free $100 from the Government if he earns $400 or less, why should be earn more than $400. Therefore, he will be tempted to reduce his work. Here the concept of substitution effect also plays a role. The individual will reduce his per month consumption of Good A and Good B so that he can sustain at $00 or less or substitute Good A and Good B with Good C and Good D, which are cheaper and helps him to sustain somehow, without having to work more.
Answer (b) :
If we see the graph above, we see that Good A is measured in the X axes and Good B is measured in the Y axes. Here, the curve PQ is the budget constraint. i.e. at his income level of $2000, he will choose OP units of Good B and OQ unit of Good A. Now, if the individual realizes that he will earn an additional $120 subsidy from the Government, the individual also leans that until the amount is paid back his income will be deducted by 20% until it reaches $ 500, This will tempt the individual to work more and to increase his work. In the graph we can see that as a result of the subsidy by the Government, the individual now consumes more quantities of both goods A and B and his new budget constraint is RS.
Answer( c) : The same graph GRAPH 1 will also help us to understand how the EITC reduces the interest to work for an individual. When the individual realizes that he is getting a subsidy from the government, the individual will become self-satisfactory and start to consume the new increased quantity of Good A and Good B and be satisfied with what he is consuming and thereby be reluctant to work harder. This will lead to a scenario where in the long run, his net income will reduce and his budget constraint will be lower than the original budget constraint.