Answer to Question #160961 in Economics for Bella

Question

The welfare system provides income to some needy families. Typically, the maximum payment goes to families that earn no income; then, as families begin to earn income, the welfare payment declines gradually and eventually disappears. Let’s consider the possible effects of this program on a family’s labor supply.

a. Draw a budget constraint for a family assuming that the welfare system did not exist. On the same diagram, draw a budget constraint that reflects the existence of the welfare system.

b. Adding indifference curves to your diagram, show how the welfare system could reduce the number of hours worked by the family. Explain, with reference to both the income and substitution effects.

c. Using your diagram from part (b), show the effect of the welfare system on the well-being of the family.

Answer 1

a. A budget constraint for a family is a straight downward-sloping line, if the welfare system did not exist. A budget constraint that reflects the existence of the welfare system will be to the right from the first budget constraint.

b. Indifference curves are downward-sloping curves, some of them cross the budget line in optimal consumption points. The welfare system could reduce the number of hours worked by the family, because it can afford the same level of utility from the indifference curve while working less.

c. The welfare system increases the well-being of the family, because it can reach the higher indifference curve working the same time.