QUESTION 3

Consider a welfare program in which individuals who do not earn any income receive $150 in benefits. The individual can earn up to $100 without losing benefits but for earnings above $100 for each additional dollar earned 75 cents of benefits are withdrawn.

1. (a)Assume that an individual can earn $10 per hour and has no other income. Sketch her
2. budget constraint with and without the program in effect. Carefully label the axes,
3. intercepts and kink points. (2 points)
4. (b)For an individual earning $100 dollars before the introduction of the welfare plan explain
5. how hours of work and total income are affected by the introduction of such a welfare
6. plan. (2 points)
7. (c)For an individual earning $300 dollars before the introduction of the welfare plan explain
8. how hours of work and total income are affected by the introduction of such a welfare plan. Use the diagram to (i) illustrate the income and substitution effects of the welfare program and (ii) show how a fixed subsidy could lead that individual to the same level of utility at lower cost. (3 points)
9. (d)Discuss the advantages and disadvantages of means testing welfare benefits. (3 points)