Consider an income guarantee program with an income guarantee of $5,000 and a benefit reduction rate of 40%. A person can work up to 2,000 hours per year at $10 per hour.
a. Draw the person’s budget constraint with the income guarantee.
b. Suppose that the income guarantee rises to $7,500 but with a 60% reduction rate. Draw the new budget constraint.
c. Which of these two income guarantee programs is more likely to discourage work? Explain.
d. Draw a system of smooth indifference curves that bend the right way but would lead an agent to work more under the program you chose in part c than under the other program. Describe what seems extreme about these curves that leads to the unusual behavior.