Question

Suppose a single parent can work up to 16 hours per day at a wage rate of $10.00 per hour. Various income maintenance programs have been developed to assure a minimum level of income for low-income families. Aid to Families with Dependent Children (AFDC) was established with the Social Security Act of 1935. The family was given an income subsidy depending on family size. Under this program, the family’s benefit was reduced by $1 for every dollar earned. Suppose the maximum subsidy for the single parent described above is $40.

a. Draw the daily budget constraint without program participation for the single parent described above.

b. On the same graph, draw the daily budget constraint under AFDC for the single parent described above.

c. What effect does this program have on the incentive to work? Explain.

Answer 1

c) Those with relatively steep indifference curves, who were not working before, will continue not working even with the subsidy provided; Their effective wage rate turns to zero after with the provided subsidy. If the maximum AFDC subsidy is $40, eligible participants who would work up to 4 hours per day can attain a higher utility if they choose to receive the subsidy under AFDC and not work at all.