17.10 Public choice of unemployment benefits Suppose individuals face a probability of u that they will be unemployed next year. If they are unemployed they will receive unemployment benefits of

b, whereas if they are employed they receive w (l – t), where t is the tax used to finance unemployment benefits. Unemployment ben efits are constrained by the government budget constraint ub = tw (l – u).

a.

Suppose the individual’s utility function is given by U = (yi

)δ/δ, where 1 – δ is the degree of constant relative risk aversion. What would be the utility-maximising choices for b and t?

b.

c.

How would the utility-maximising choices for b and t respond to changes in the probability of unemployment, u?

How would b and t change in response to changes in the risk aversion parameter δ?