Question

Consider an income guarantee program with an income guarantee of $6,000 and a benefit reduction rate of 50%. A person can work up to 2,000 hours per year at $8 per hour. A. Draw the person’s budget constraint with the income guarantee. B. Suppose that the income guarantee rises to $9,000 but with a 75% reduction rate. Draw the new budget constraint. C. Which of these two income guarantee programs is more likely to discourage work? Explain.

Answer 1

Answer:

A. Please see attachment .

B.Please see attachment . B) Benefits will end under these conditions when earned income is $9,000/.75 = $12,000, just as shown in a. The difference is that the all-leisure income is higher, but the slope of the line segment from 500 hours of leisure to 2,000 hours of leisure is flatter.

C. (C) A higher income guarantee with a higher reduction rate is more likely to discourage work for two reasons

Explanation:

(C) A higher income guarantee with a higher reduction rate is more likely to discourage work for two reasons.  First, not working at all yields a higher income.  Second, a person who works less than 1,500 hours will be allowed to keep much less of his or her earned income when the effective tax rate is 75%. With a 75% benefit reduction rate, the effective hourly wage is only $2 per hour (25% of $8).