Question

Let’s start with some history: Low-income assistance programs in US began, in a broad scale, during the 1960s with the “War on Poverty” programs and later the Family Assistance Plan, none of which provided income without some connected restriction (how much they worked, how the money was spent, family characteristics, etc. For example, Aid to Families with Dependent Children (AFDC), started in the 1960’s, provided single-earner households a monthly cash assistance only if they had dependent children and fell below a certain income level. However, if an AFDC participant worked, then their monthly government cash assistance was reduced by $1 for every $1 earned. Below you are asked to use the labor-leisure model to explain the impacts of the program on work decisions.

First, start by drawing a labor-leisure graph to show the budget constraint (intercepts, slope) for a person that earns $10 wage per hour worked and has 300 hours per month available to allocate between leisure and work. Include an indifference curve showing the person maximizes utility working 100 hours (also, show leisure hours and income on graph).

Second, on the same graph, draw the budget constraint with an AFDC-type of assistance program, where the government guarantees the person $500 minimum monthly income (even if they do not work) but reduces the $500 assistance by $1 for every $1 the person earns at work (i.e., earn $10, assistance reduced to $490). The budget constraint is a little tricky: It may help to think about how much income a person has if they don’t work at all, then their amount of earned income and government assistance if work one hour, two hours, etc.) How do you expect this government program to impact the person’s work decisions? Work more, less, no effect? Explain using labor-leisure model/graph and relevant concepts.

b. Now show graphically the effect of the Stockton experimental basic-income program on your labor leisure graph, where $500 cash assistance is given with no restrictions. Explain you expect the work incentives under the Stockton program compare to the program in part a.

Answer 1

$10 wage per hour worked and has 300 hours per month

the person maximizes utility working 100 hours (200 leisure hours). Graph is shown below:

2) AFDC-type of assistance program: For each hour worked, $1 will be deducted from monthly assisstance. For example, i the person works 10 hours, his income will be: wage $10+ $490 monthly assisstance= $500. Upto 50 working hours, the monthly wage will be fixed at $500, after that monthly assistance will vanish and person will work according to market wage rate:

From this graph, we can analyse that the person will not prefer to work for first 50 hours. Because according to principle of Revealed Preference, a person is much better off by not working in the first 50 hours. But after that, his preferences will be similar as in the previous case because s/he will face same budget constraint.

3) $500 cash assistance is given with no restrictions: Income at each hour worked will increase by $500, hence budget line will shift outwards:

We can see that with shift in budget line, a person can avail more income without working much. Ceteris paribus, this income can induce the person to work less (In this case income effect>substitution effect).