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58 PA R T I INTRODUCTION AND BACKGROUND

TANF-like programs introduce complicated budget underlying utility maximization) equals supply
constraints with several possible segments, depend- (which is derived from underlying profit maxi-
ing on whether a mother is on or off the program. mization).
Reducing TANF benefits is likely to increase the Social welfare is maximized by using a social
labor supply of single mothers, but the size of the welfare function to incorporate both efficiency and
increase is unclear and depends on the mothers societys preferences for redistribution into policy
preferences for leisure and consumption. making.
Social welfare is determined by considering both Since reducing TANF benefits moves the labor
social efficiency (the size of the pie) and equity (the market closer to the competitive equilibrium, it
distribution of the pie). raises total social efficiency, but at a cost of lowering
Social efficiency is maximized at the competitive the incomes of a particularly needy group. The net
equilibrium, where demand (which is derived from impact on social welfare is unclear.

QUESTIONS AND PROBLEMS

1. The price of a bus trip is $1 and the price of a gal- b. Think about your answer to (a). Show that
lon of gas (at the time of this writing!) is $2. What government redistribution from rich to poor
is the relative price of a gallon of gas, in terms of can still be consistent with either of the two
bus trips? What happens when the price of a bus social welfare functions.
trip falls to $0.75?
7. Since the free market (competitive) equilibrium
2. Draw the demand curve Q 200 10P. Calcu- maximizes social efficiency, why would the gov-
late the price elasticity of demand at prices of $5, ernment ever intervene in an economy?
$10, and $15 to show how it changes as you move 8. Consider an income guarantee program with an
along this linear demand curve. income guarantee of $6,000 and a benefit reduc-
3. You have $100 to spend on food and clothing. The tion rate of 50%. A person can work up to 2,000
price of food is $5 and the price of clothing is $10. hours per year at $8 per hour.
a. Graph your budget constraint. a. Draw the persons budget constraint with the
b. Suppose that the government subsidizes cloth- income guarantee.
ing such that each unit of clothing is half-price, b. Suppose that the income guarantee rises to
up to the first five units of clothing. Graph your $9,000 but with a 75% reduction rate. Draw
budget constraint in this circumstance. the new budget constraint.
c. Which of these two income guarantee programs
4. Use utility theory to explain why people ever
is more likely to discourage work? Explain.
leave all-you-can-eat buffets.
9. A good is called normal if a person consumes more
5. Explain why a consumers optimal choice is the
of it when her income rises (for example, she might
point at which her budget constraint is tangent to
see movies in theaters more often as her income
an indifference curve.
rises). It is called inferior if a person consumes less of
6. Consider the utilitarian social welfare function it when her income rises (for example, she might be
and the Rawlsian social welfare function, the two less inclined to buy a used car as her income rises).
social welfare functions described in Chapter 2. Sally eats out at the local burger joint quite fre-
a. Which one is more consistent with a govern- quently. The burger joint suddenly lowers its prices.
ment that redistributes from rich to poor? a. Suppose that, in response to the lower burger
Which is more consistent with a government prices, Sally goes to the local pizza restaurant
that does not do any redistribution from rich less often. Can you tell from this whether or
to poor? not pizza is an inferior good for Sally?