Economics of Policy Issues
EC3060
Spring 2015
Tutorial Notes 2
Michael King
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Outline
Purpose of Tutorial
• Opportunity to ask questions
• Revision
Contents
1. Summer Examination
2. FSIC and the Real World
3. Attributes and consequences of
entitlements
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1. Summer Examination
• 3 hour exam
• Section A: John O’Hagan
– 4 Questions
– Must answer 2 questions
• Section B: Michael King
– 4 questions (3 Questions as advised plus one other)
– Full year students must answer 2 questions (45 mins
per question)
– Module B only: Students must answer 2 questions from
Section B (45 minutes per question)
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Advice on Answering
Exam Questions
• Make sure you answer all parts of the question!
• To strengthen introduction/conclusions
– Refer to some other relevant material, cross
referencing material
– Interpret the material in slightly more innovative ways
• Use of Examples
– Political Competition: New labours economic policies
in 1997 or the election between Gore, Bush jr and
Ralph Nader in 2000.
– Examples from the real world of absenteeism?
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What Will Achieve High Marks?
1.
2.
3.
4.
5.
Each answer should have an introduction and
conclusion. Each paragraph should have a specific
theme, argument or purpose.
Using all relevant material covered in class and in the
core text book to answer each question.
Using material in the supplementary readings.
Arguments from elsewhere will receive bonus marks.
Presenting clearly and explaining well the
technical details through diagrams, algebra, including
reference to assumptions.
Enlightened discussion of relevant material that is
precise, skillfully ties the material together, recognises
alternative perspectives and makes reference to useful
examples where possible.
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2. The Graph to Remember
•
Introducing the Feasible Social Insurance
Curve (FSIC) with
1. Diminishing Marginal Utility
2. The Leaky Bucket of Redistribution
3. The Laffer Curve
for any shape of social welfare function
 The three effects combine to determine the feasible
welfare outcomes as redistribution takes place
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Net Taxes by HH Type (2007)
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Results for Social Welfare
• Choice of the social insurance contract
through choice of a social welfare
function is a choice between greater
ex-post equality and greater
efficiency/overall better off through
higher utility
Choice is between B2 and G2.
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Back to the Real World…..
• Issue 1: Debate on whether to increase
taxes on high earners to cover the fiscal
crisis
Answer depends on level of the
Laffer curve (labour mobility, effect on FDI)
Leaky bucket of redistribution (reduction of
labour supply)
Notions of Social Justice: Strong calls in
favour
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• Issue 2: To increase taxes on medium
taxpayers?
• Answer depends on level of the
 Laffer curve (labour mobility of young highly skilled
Europeans, low mobility for most workers)
 Leaky bucket of redistribution (reduction of labour
supply, not likely to be that high except for parents)
 Suggested by Mireelss
 Notions of Social Justice: Politically difficult
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• Issue 3: Debate on whether to reduce welfare
payments in the current unemployment crisis
 Answer depends on level of the
 Leaky bucket of redistribution (welfare traps)
 Notions of Social Justice: Occurred at budget 2010,
many people appalled but not that much opposition.
Strong arguments to actually increase welfare
payments!
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• Issue 4: Debate on whether society should now
focus on building a more equal society, what
social welfare function do we believe in
 Answer depends on level of the
 Laffer curve (a focus on Bentham eliminates potential impact)
 Leaky bucket of redistribution (a focus on Bentham reduces the
impact, maybe helps out of recession by generating growth,
lower DWL)
 Notions of Social Justice: Larger political grouping in support of
redistribution, crisis can be used for moving towards either
extreme
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Perceptions rather than estimations of
the LBR or Work Ethic
Alesina and Glaeser (2004) and Gottschalk and Spolaore (2002)
United States
Europe
 29 percent of Americans
surveyed believe that the poor
are trapped in poverty
 60 percent of Americans believe
that the poor are lazy.
 60 percent of the members of
the bottom quintile of the income
distribution in the U.S. in 1984
remained in that quintile in 1993.
 60 percent of Europeans believe
that the poor are trapped.
 26 percent of Europeans share
that belief that poor are lazy
(Alesina and Glaeser, 2004).
 46 percent of Germans in the
bottom quintile of their income
distribution remained in that
bottom quintile 9 years later.
In addition the bottom quintile of the American income distribution works far more
hours than their counterparts in many European countries.
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3. Entitlements
•
Types of entitlements include:
1.
2.
3.
4.
5.
6.
7.
Universal entitlements (not covered today)
Targeted entitlements (not covered today)
Cash transfers
In kind transfers
Vouchers (not covered today)
Wage subsidies (not covered today)
Income Transfers (not covered today)
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Income v’s In-kind Transfer:
Recipients Perspective
1. Initial pre-transfer budget constraint is AB
2. Income entitlement of AE
3. Slope of budget lines represents relative price of
education
4. Each household has a different preference for
education
5. ICC traces combination of goods chosen as the
budget constraint is relaxed (determined by utility
indifference curves)
6. Alternatively, transfer is in kind AG or BD of education
7. Household 1 can only reach G (lower utility than at
C2)
8. Recipients prefer entitlements in terms of income
rather in-kind because of greater freedom of choice
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Income v’s In-kind Transfer:
Taxpayer Perspective
1. Two HHs with different incomes but the
same preference for education (common
ICC)
2. YH, YL = pre-tax income
3. When no government schooling education
chosen at H and L respectively
4. Govt now sets QG > Q1 and ex-ante
equality is achieved when both sent their
children to govt schools
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5.
6.
7.
8.
9.
In-kind transfer to HL of (QG – Q1) and continues to pay
for Q1 through taxes, with excess burden (although not
drawn in graph)
HH pays (YH – SH) = (SL – YL) for the in-kind transfer
Even with the lower income HH wants Q2 rather than
QG as a result is compelled to be at point B at a lower
utility level
Instead the HL could receive (SL – YL) and would
chose point D. To reach QG, HL would require income
transfer V, where the two HHs have the same income
in this example
higher taxation and DWL
Taxpayers prefer in-kind transfers as the objective is to
provide everyone with QG
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Rejection of Government in-kind
Transfer
• The decision to reject a government’s schooling
entitlement
• Assume public and private schools are pure
substitutes (same cost, reflected in slope of
budget line)
• We consider households with
– Same incomes
– Different preferences regarding spending on
schooling
– The excess burden of taxation is omitted graphically
but is present from the figures
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1. Two HHs have same pre-tax income OA
2. Govt introduces QG as an in-kind
entitlement
3. Introduce option to reject QG and forgo
the taxes paid
4. OC is disposable income after tax AC
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6.
7.
8.
Point J along HD provides higher utility and as a result
pays for Q3. Without the tax the HH would chose Q2
at point F
Hence, the entitlement reduces utility for a household
that rejects the entitlement
HH would be prepared to pay JF to end the entitlement
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Rejection Determined by Slope of
IC curves: Case of Acceptance
• HH accepts entitlement
because G exceeds the
utility attainable through
after tax spending at any
point along HD
• HH is prepared to pay
FN to avoid entitlement
• The entitlement reduces
utility for a household
that accepts the
entitlement
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• Note: Curvature of the indifference curves
revealed the relative valuation of additional
education
• Each household was better off, by its own
valuation of its own well-being, without the
government entitlement
• Who loses more?
– Both households lose from the entitlement but the
household that more highly values education loses
more
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Questions?
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