© 2002 mcgraw-hill ryerson ltd.chapter 3-1 chapter three labour supply and public policy: work...
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© 2002 McGraw-Hill Ryerson Ltd. Chapter 3-1
Chapter Three
Labour Supply and Public Policy:
Work Incentive Effects of Alternative Income Maintenance Schemes
Created by: Erica Morrill, M.Ed Fanshawe College
© 2002 McGraw-Hill Ryerson Ltd. Chapter 3-2
Chapter FocusLabour Supply Factors
Government transfer programs Welfare programs Workers compensation Child-care subsidies
© 2002 McGraw-Hill Ryerson Ltd. Chapter 3-3
Income Maintenance SchemesDesigned to supplement low incomesNo single program can address the
multiple reasons for low income Difficult for policy makers to design the
ideal program
© 2002 McGraw-Hill Ryerson Ltd. Chapter 3-4
Universal ProgramsAdministratively simpleEveryone receives the same transfer
regardless of income Results in raising income and
eliminating povertyExpensiveBenefits non-poor
© 2002 McGraw-Hill Ryerson Ltd. Chapter 3-5
Perfect Targeting Cheaper method Individuals are given exactly enough of a
transfer to reach the poverty line Only those below poverty line would receive
transfer Individuals below poverty line are guaranteed
to be topped up May cause individuals to reduce work effort Creates a disincentive to earn income
© 2002 McGraw-Hill Ryerson Ltd. Chapter 3-6
Permanent or Transitory Design features
to compensate for low wages or lack of hours
Distinction between permanent and transitory are difficult to isolate
© 2002 McGraw-Hill Ryerson Ltd. Chapter 3-7
Characteristics of a DemograntLump sum transfer Income grantSpecific to a demographic group
Old Age Security (OAS)Universal
© 2002 McGraw-Hill Ryerson Ltd. Chapter 3-8
demogrant
Figure 3.1 Work Incentive Effects of a Lump Sum Demogrant
0
U0
T
E0
-income constraint shiftsup by amount of the grant
- slope is the same and there is no substitution effect
- if working time is not altered the equilibriumis E1
Income
Leisure
U1
E1 Y1
Ud
EdYd
© 2002 McGraw-Hill Ryerson Ltd. Chapter 3-9
Work Incentive Effects of a Lump Sum Demogrant
No substitution effect Work incentives are reducedPure leisure - inducing income effect Increase in income is less than the
demogrant (used to buy leisure)
© 2002 McGraw-Hill Ryerson Ltd. Chapter 3-10
WelfareAdministered by the provincesFinanced partly by the federal
governmentBenefits depend on
needs of the family, assets other sources of income
© 2002 McGraw-Hill Ryerson Ltd. Chapter 3-11
Figure 3.2 Welfare: 100% “Claw-Back”
0
U0
T
E0
- at max leisure the income constraintshifts vertically up by the welfare payment
- potential income constraint is horizontal at the amount of the welfare payment
-strong incentive to move to corner solution
Welfarebenefit
Y0
Uw
Ew
Yw
© 2002 McGraw-Hill Ryerson Ltd. Chapter 3-12
Welfare:100% “Claw Back”Adverse effect on work incentivesWork is not chosen because of the
100% tax on earned incomeNegative impact on work incentives Not an acceptable policy
© 2002 McGraw-Hill Ryerson Ltd. Chapter 3-13
U0
E0
Figure 3.3 a Welfare Reduce Benefit
0 T
- lower welfare payments
- no incentive to go on welfaresince the individual is alreadymaximizing at E0
Uw’
Welfarebenefit
© 2002 McGraw-Hill Ryerson Ltd. Chapter 3-14
Welfare: Reduce BenefitSuccessful in reducing the number of
people on welfareMay deny welfare to those in need Inadequate income support to
unemployable
© 2002 McGraw-Hill Ryerson Ltd. Chapter 3-15
- wage rate to encourage individuals to voluntarily leave welfare
Figure 3.2 b Welfare:Increase Wage Rate
0
U0
Uw
T
E1
Ew
Welfare benefit
© 2002 McGraw-Hill Ryerson Ltd. Chapter 3-16
Welfare
Increase Wage Rate through: training job information mobility government wage subsidy institutional pressure (unionization, minimum
wage)
Costly Increase work incentives
© 2002 McGraw-Hill Ryerson Ltd. Chapter 3-17
- tax by requiring recipients togive up only a portion of welfareif they earn income by working
Figure 3.2 c Welfare:Reduce the Implicit Tax
0
Uw
T
Uw ’
Ew ’
Welfarebenefit
Ew
© 2002 McGraw-Hill Ryerson Ltd. Chapter 3-18
Figure 3.2 d Welfare: Change Preferences
0 T
Welfarebenefit
U0E0
-alter preferences away from welfareflattens the indifference curve
© 2002 McGraw-Hill Ryerson Ltd. Chapter 3-19
Negative Income Tax income guarantee Implicit tax rate of less than 100%Recipients receive more from the
guarantee than they will pay out in taxes Child Tax Credit Guaranteed Income Supplement
© 2002 McGraw-Hill Ryerson Ltd. Chapter 3-20
EoG
Slope=(1-t)w
-income guarantee shifts the income constraint up the amount of the guarantee
0
U0
T
Figure 3.4 Effects of a Negative Income Tax
B
- income support declines as incomefrom work increases
slope = w
Leisure
Income
UN
EN
© 2002 McGraw-Hill Ryerson Ltd. Chapter 3-21
0
Figure 3.5 Wage Subsidy
T
U0
E0
Us
Es
-as with a wage a subsidy rotates the income constraintupward
-substitution effect and income effect work in opposite directions
© 2002 McGraw-Hill Ryerson Ltd. Chapter 3-22
Wage SubsidyTheoretically indeterminate Adverse effects of wage subsidy are not
as great as those of the negative income tax
Disadvantage does nothing for the income of those who
are unable to work
© 2002 McGraw-Hill Ryerson Ltd. Chapter 3-23
0
Figure 3.6 Wage Subsidy vs. Negative Income Tax
T
Uwage subsidy
Es
ENnegative income tax
Leisure
Income
© 2002 McGraw-Hill Ryerson Ltd. Chapter 3-24
Figure 3.8 Unemployment Insurance-Assisted Work-Sharing
0 7
Y0
U0
E0
2 3 4 Days5 Days
- income falls by 40 percent forevery day of work reduction
-new equilibrium is on higher indifference curve because the individual gets a day of leisurefor only a 40% drop in income
Es
Ys Us
© 2002 McGraw-Hill Ryerson Ltd. Chapter 3-25
Effect of a Disability Budget constraint or preference curve
could be alteredFactors to be considered:
hours able to work medical expenses reduced ability to earn wages disutility of labour market vs. other
activities
© 2002 McGraw-Hill Ryerson Ltd. Chapter 3-26
0
U0
Income
LeisureH0
Y0
Figure 3.10 a Effect of Compensation
Hf
Yd=2/3Y0
- two thirds of the loss of income
- compensation is available for anycombination of partial disabilities
© 2002 McGraw-Hill Ryerson Ltd. Chapter 3-27
0
U0
Income
LeisureH0
Y0EC
Uc
Figure 3.10 b Compensation: No Incentive to Return to Work
Hf
Utility under compensation isgreater than utility under work
Uf
Not providing compensationwould reduce individual’s utility to Uf
© 2002 McGraw-Hill Ryerson Ltd. Chapter 3-28
0
U0
Income
LeisureH0
Y0
CUY
Figure 3.10 c Compensation: Restoring Income
Y
M
Ud
- permanent injury forces individual to locate at Hf
- medical costs reduce utility toUd
- court award for income & medicalIf court
wanted to restore individual to former utility
Hf
© 2002 McGraw-Hill Ryerson Ltd. Chapter 3-29
0 T
Figure 3.11 Child Care: Impact on Budget Constraint
Income
Leisure
A
B
E
MCost of Daycare
Y
Y-m
- fixed day-care cost results ina vertical drop in the budget constraint
© 2002 McGraw-Hill Ryerson Ltd. Chapter 3-30
Figure 3.11 b Day-Care: Impact on Participation
0
U0E
MR
Income
LeisureT
E0
Hm
- if market wage below reservation wage, individual is better off engaging in nonlabour activities
M’
R’
- slope of MM’ is greater than RR’ indicating a reservation wage greater due
to fixed day-care costs
© 2002 McGraw-Hill Ryerson Ltd. Chapter 3-31
Em
0 T
Income
Leisure
M
Figure 3.11c Day-Care:Impact on Hours Worked
Eo
M’U0
U1
H1 H0Hm
- Eo no child care costs
- day-care costs shift the budget constraint down parallel since market wages haven’t changed
- indicate the number of hours below which it would not be worth while
to enter the labour market
© 2002 McGraw-Hill Ryerson Ltd. Chapter 3-32
Day-care SubsidyEncourages labour force participation
and part-time workReduces the hours of work for those
already participating
© 2002 McGraw-Hill Ryerson Ltd. Chapter 3-33
End of Chapter Three
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