THE SPESIFICATION OF INDIVIDUAL
CHOICE MODELS FOR THE ANALYSIS OF
WELFARE PROGRAMS
MICROECONOMIC POLICY ANALYSIS
LEE S. FRIEDMAN
JOHNNY PATTA
KK PENGELOLAAN PEMBANGUNAN DAN PENGEMBANGAN KEBIJAKAN
SAPPK - ITB
7/14/2017
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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 policyimposed restrictions on individual choice
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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
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STANDARD ARGUMENT-IN-KIND WELFARE
TRANSFERS ARE INEFFICIENT (2)
• The line AB represents the
budget constraint of a lowincome 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
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STANDARD ARGUMENT-IN-KIND WELFARE
TRANSFERS ARE INEFFICIENT (3)
• 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
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STANDARD ARGUMENT-IN-KIND WELFARE
TRANSFERS ARE INEFFICIENT (4)
• 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
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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
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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.
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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.
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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
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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.
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CHOICE RESTRICTIONS IMPOSED BY POLICY (3)
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
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CHOICE RESTRICTIONS IMPOSED BY POLICY (4)
• 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.
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CHOICE RESTRICTIONS IMPOSED BY POLICY (5)
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
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CHOICE RESTRICTIONS IMPOSED BY POLICY (6)
• 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.
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CHOICE RESTRICTIONS IMPOSED BY POLICY (4)
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
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CHOICE RESTRICTIONS IMPOSED BY POLICY (5)
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
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CHOICE RESTRICTIONS IMPOSED BY POLICY (6)
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.
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CHOICE RESTRICTIONS IMPOSED BY POLICY (7)
• 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.
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THANK YOU
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