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Chapter 3

Chapter 3


Department
Economics
Course Code
ECO100Y1
Professor
Erik Gunderson
Chapter
3

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CHAPTER 3
To analyze the effect of specific programs on the income constraint, ask:
i)What is the effect on non labour income?
ii)What is the effect on the slope of the constraint that is, what happens as the
individual gives up leisure and works more?
Y = income after taxes and transfer payments
E = labour market earnings = wages times hours worked
Demogrant: a lump-sum transfer allocated to the worker regardless of his or her work effort
or how many or few hours that he or she works (ie. Old Age Security)
the demogrant would shift the potential income constraint vertically upward by the
amount of the grant; the slope of the new income constraint would be equal to the slope of
the original constraint since the relative price of leisure has not changed (price of leisure
remains the same, no substitution effect)
work incentives are unambiguously reduced
leisure-inducing pure income effect
Welfare program: a social program (also called social assistance) that typically allocates
demogrant payments to nonparticipants of the labour force; the amounts are based
primarily on the survival needs of the family, and the implicit tax on labour market
earnings is 100 percent
as they work and earn in income, they forgo a comparable amount in welfare and hence
their income does not increase
if the welfare payment is sufficiently high, the individual would have a strong incentive to
move to the corner solution where he would not work at all
Negative income tax: a special type of social assistance program containing an incentive
structure that does not penalize the act of working; a level of income is guaranteed, and the
implicit tax rate on labour market earnings is not 100 percent, as is the case for
conventional social assistance programs
Y = G + (1 t)E, where G = basic guarantee, t = implicit tax rate, Y = take-home pay, E =
labour market earnings, G > tE
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