© 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 Focus  Labour Supply Factors  Government transfer programs  Welfare programs  Workers compensation  Child-care subsidies

© 2002 McGraw-Hill Ryerson Ltd.Chapter 3-3 Income Maintenance Schemes  Designed to supplement low incomes  No 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 Programs  Administratively simple  Everyone receives the same transfer regardless of income  Results in raising income and eliminating poverty  Expensive  Benefits 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 Demogrant  Lump sum transfer  Income grant  Specific 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 U0U0 T E0E0 -income constraint shifts up by amount of the grant - slope is the same and there is no substitution effect - if working time is not altered the equilibrium is E 1 Income Leisure U1U1 E1E1 Y1Y1 UdUd EdEd YdYd

© 2002 McGraw-Hill Ryerson Ltd.Chapter 3-9 Work Incentive Effects of a Lump Sum Demogrant  No substitution effect  Work incentives are reduced  Pure leisure - inducing income effect  Increase in income is less than the demogrant (used to buy leisure)

© 2002 McGraw-Hill Ryerson Ltd.Chapter 3-10 Welfare  Administered by the provinces  Financed partly by the federal government  Benefits 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 U0U0 T E0E0 - at max leisure the income constraint shifts 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 Welfare benefit Y0Y0 UwUw EwEw YwYw

© 2002 McGraw-Hill Ryerson Ltd.Chapter 3-12 Welfare:100% “Claw Back”  Adverse effect on work incentives  Work is not chosen because of the 100% tax on earned income  Negative impact on work incentives  Not an acceptable policy

© 2002 McGraw-Hill Ryerson Ltd.Chapter 3-13 U0U0 E0E0 Figure 3.3 a Welfare Reduce Benefit 0 T - lower welfare payments - no incentive to go on welfare since the individual is already maximizing at E 0 U w’ Welfare benefit

© 2002 McGraw-Hill Ryerson Ltd.Chapter 3-14 Welfare: Reduce Benefit  Successful in reducing the number of people on welfare  May deny welfare to those in need  Inadequate income support to unemployable

© 2002 McGraw-Hill Ryerson Ltd.Chapter  wage rate to encourage individuals to voluntarily leave welfare Figure 3.2 b Welfare:Increase Wage Rate 0 U0U0 UwUw T E1E1 EwEw 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  tax by requiring recipients to give up only a portion of welfare if they earn income by working Figure 3.2 c Welfare:Reduce the Implicit Tax 0 UwUw T U w ’ E w ’ Welfare benefit EwEw

© 2002 McGraw-Hill Ryerson Ltd.Chapter 3-18 Figure 3.2 d Welfare: Change Preferences 0 T Welfare benefit U0U0 E0E0 -alter preferences away from welfare flattens 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 EoEo G Slope=(1-t)w -income guarantee shifts the income constraint up the amount of the guarantee 0 U0U0 T Figure 3.4 Effects of a Negative Income Tax B - income support declines as income from work increases slope = w Leisure Income UNUN ENEN

© 2002 McGraw-Hill Ryerson Ltd.Chapter Figure 3.5 Wage Subsidy T U0U0 E0E0 UsUs EsEs -as with a wage  a subsidy rotates the income constraint upward -substitution effect and income effect work in opposite directions

© 2002 McGraw-Hill Ryerson Ltd.Chapter 3-22 Wage Subsidy  Theoretically 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 Figure 3.6 Wage Subsidy vs. Negative Income Tax T U wage subsidy EsEs ENEN negative income tax Leisure Income

© 2002 McGraw-Hill Ryerson Ltd.Chapter 3-24 Figure 3.8 Unemployment Insurance- Assisted Work-Sharing 0 7 Y0Y0 U0U0 E0E Days 5 Days - income falls by 40 percent for every day of work reduction -new equilibrium is on higher indifference curve because the individual gets a day of leisure for only a 40% drop in income EsEs YsYs Us

© 2002 McGraw-Hill Ryerson Ltd.Chapter 3-25 Effect of a Disability  Budget constraint or preference curve could be altered  Factors 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 U0U0 Income Leisure H0H0 Y0Y0 Figure 3.10 a Effect of Compensation HfHf Y d =2/3Y 0 - two thirds of the loss of income - compensation is available for any combination of partial disabilities

© 2002 McGraw-Hill Ryerson Ltd.Chapter U0U0 Income Leisure H0H0 Y0Y0 ECEC UcUc Figure 3.10 b Compensation: No Incentive to Return to Work HfHf Utility under compensation is greater than utility under work UfUf Not providing compensation would reduce individual’s utility to U f

© 2002 McGraw-Hill Ryerson Ltd.Chapter U0U0 Income Leisure H0H0 Y0Y0 C UYUY Figure 3.10 c Compensation: Restoring Income Y M UdUd - permanent injury forces individual to locate at H f - medical costs reduce utility to U d - court award for income & medical If court wanted to restore individual to former utility HfHf

© 2002 McGraw-Hill Ryerson Ltd.Chapter T Figure 3.11 Child Care: Impact on Budget Constraint Income Leisure A B E M Cost of Daycare Y Y-m - fixed day-care cost results in a vertical drop in the budget constraint

© 2002 McGraw-Hill Ryerson Ltd.Chapter 3-30 Figure 3.11 b Day-Care: Impact on Participation 0 U0U0 E M R Income LeisureT E0E0 HmHm - 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 EmEm 0 T Income Leisure M Figure 3.11c Day-Care:Impact on Hours Worked EoEo M’ U0U0 U1U1 H1H1 H0H0 HmHm - E o 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 Subsidy  Encourages labour force participation and part-time work  Reduces the hours of work for those already participating

© 2002 McGraw-Hill Ryerson Ltd.Chapter 3-33 End of Chapter Three