the spesification of individual choice models for the analysis of welfare programs microeconomic...

THE SPESIFICATION OF INDIVIDUAL CHOICE MODELS FOR THE ANALYSIS OF

WELFARE PROGRAMS

MICROECONOMIC POLICY ANALYSISLEE S. FRIEDMAN

JOHNNY PATTAKK PENGELOLAAN PEMBANGUNAN DAN PENGEMBANGAN KEBIJAKAN

SAPPK - ITB

04/20/23 [email protected]

INTRODUCTION

• We consider two general types of utility functions and various alterations in budget constraints due to public policies

• The particular variations in the spesifications we explore relate to two common phneomena– The existence of external effects or spillovers– The existence of segmented or discontionous

budget constraints caused by various policy-imposed restrictions on individual choice


STANDARD ARGUMENT-IN-KIND WELFARE TRANSFERS ARE INEFFICIENT

• In the U.S. Economy all levels of government are involved in providing welfare payments (through a variety of programs) to eligible low-income persons

• These payments are transfer in the sense that they take away purchasing power from taxpayers and transfer it to welfare recipients

• Some of the programs, like Aid to Families with Dependent Children, provide cash payments; other program, like food stamps, Medicaid, and housing allowances, provide transfers in kind


STANDARD ARGUMENT-IN-KIND WELFARE TRANSFERS ARE INEFFICIENT (2)

• The line AB represents the budget constraint of a low-income individual with no welfare program

• If the consumer spends the whole budget on food, he or she can buy OB quantity of food

• If the whole budget is used to buy other things, then OA dollars worth of everything else can be bought

• Thus we also know that OA dollars is the total size of the consumer’s budget



• To maximize utility, the consumer chooses the quantities shown at D, where an indifference curve is just tangent to the new budget constraint

• The market price of OM food purchased at D must be FA, since that is the amount of budget the consumer would have been required to give up to purchase the same quantity if there were no Food Stamp Program



• Under the Food Stamp Program, the individual pays only GA for the food quantity OM

• The government must be paying FG, the difference between the market cost FA and the individual’s contribution GA

• Taxpayers pay FG dollars to bring this consumer to the indifference curve Uf

04/20/23 [email protected] 6

INTERDEPENDENCE PREFERENCE ARGUMENT: IN-KIND TRANSFERS MAY BE EFFICIENT

• One possible spesification error in utility maximization models concerns the sources of utility: the arguments or variables of the utility function

• The model of behavior as it is specified above has an implicit assumption of “selfish” preferences: the only sources of utility to individuals are from the goods and services they consume directly

• It is perfectly plausible that one individual can derive satisfaction through another person’s consumption; this is an example of an interdependence preference

• If there are interdependent preferences involving the consumption of spesific goods, then it is no longer efficient for each consumer to have the same MRS for any two goods consumed


INTERDEPENDENCE PREFERENCE ARGUMENT: IN-KIND TRANSFERS MAY BE EFFICIENT (2)

• In a social contract interpretation, all members of the society have contingent clims on their wealth and contingent entitlements to wealth. A claim or entitlement is contingent upon an individual’s future economic circumstances.

• It should be noted that this illustration is of a positive consumption externality: Smith derives pleasure or external benefits from an increase in Jone’s meat consumption.


INTERDEPENDENCE PREFERENCE ARGUMENT: IN-KIND TRANSFERS MAY BE EFFICIENT (3)

• In order to relate interdependent preferences to in-kind welfare programs,let us first consider wheter efficiency can be aachieved if all consumers independently buy and sell at the same market prices.

• The most important functions of analysis is to clarify and question the assumptions underlying a judgement about a policy.


CHOICE RESTRICTIONS IMPOSED BY POLICY

• Two general factors important to the design and evaluation of a policy:– The actual details of the policy design– The information and transaction costs necessary for

the policy’s operation and enforcement• Both factors can have important effects on the

actual opportunity sets that individuals face, and thus they should be considered when model assumptions about the opportunity sets are chosen


CHOICE RESTRICTIONS IMPOSED BY POLICY (2)

Food stamp choice restrictions• The driving force of the standard model is to

change in the price of food to food stamp recipients.

• A policy like that could easily lead to serious black-market problems-some individuals buying more stamps than they will use in order to sell them to others not legitimately eligible to obtain them.



Food Stamp Choice Restrictions• AB represents the budget contrsint

with no program; AC represents the unrestricted food stamp program as before; and ARS represents the restricted budget constraint

• Under the latter program, the individual can buy up to OT quantity of food with food stamps but above than limit must pay the regular market price for additional food

• Thus from A to R the slope of the budget constraint reflects the food stamp subsidy, and from R to S the slope is identical with that of AB



• The standard model suggest that food stamps are inefficient relative to a cash grant. The interdependent preference model suggests the opposite.

• Under the current food stamp program rules, such resales inevitably reduce the food consumption of the selling households.

• We have used the food stamps issue to illustrate how alternative specifications of models of consumer behaviour bear on policy analysis.



Public Housing Choice Restrictions• AB is the original budget

constraint with no program, and the family initially maximizes utility at C, thereby consuming OG of housing

• The public housing authority then tells the family that it may have an apartment which is of the same size as their current one but of better quality

• The family’s new budget constraint is simply the old one plus the single point E

• By the more-is-better logic, the familiy must prefere E to C, and it will accept the public housing offer



• The actual public housing programs are or are not efficient is a matter for empirical determination.

• As with food stamps, any inefficiency from too much housing might be offset by interdependent preferences.

• Microeconomic theory can be used to analyze the take –it-or-leave-it choice, another type of budget constraint that is sometimes created by public policy.



The Design of an Income Maintenance Plan• The standars analysis with which we began has

another source of oversimplification in its partial equlibrium nature.

• The partial equlibrium nature is focused on only one of the resource allocation choices that is affected by a program

• General equilibrium analysis requires that all the resource allocation choices affected by a program be considered



The Labor-Leisure Choice• The basic sources of individual wealth are gifts:

material things, like inheritance; childhood upbringing, like schooling received; and natural endowments, like intelligence

• Individuals use these gifts over time to alter their wealth further, increasing it through labor or capital invesments, and decreasing it through consumption

• One constraint individuals face in earning labor income is the wage offered them, but the more important constraint is time



The NIT Proposal• The NIT has been proposed as a federal response to

a variety of diffculities in welfare programs, including some not previously mentioned.

• One version of the NIT plan would replace most existing welfare programs, guarantee a certain minimum income level and tax any earnings at a rate of the order of 50% until the family preferred to no longer participate in NIT and went off welfare.



• The problem was identified as poor work incentives and we simply use knowledge about income and subtitution effects to understand it and theoritically develop an idea which might mitigate it.

• If it is impossible to determine efficiency effects precisely, the next best thing to do may be to suboptimize.


THANK YOU


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