Assume the average worker has 100 hours of leisure or work and could earn $10 an hour. Suppose the Social Security disability insurance (DI) program was structured so that otherwise eligible recipients lost their entire disability benefit if they had any labor market earnings at all. Suppose, too, that Congress was concerned about the work disincentives inherent in this program, and that the relevant committee was studying two alternatives for increasing work incentives among those disabled enough to qualify for it. Alternative A was to reduce the benefits paid to all DI recipients (from $500 to $300) but make no other changes in the program.

a) Draw original budget constraint (with a $500 DI benefit) and the budget constraint under alternative A.

b) Can this program increase labor supply? Explain how it possible or impossible. If yes show how graphically.

c) Can this program have no effect on labor supply? If yes show how graphically.

d) Can this program decrease labor supply? Explain how it possible or impossible. If yes show how graphically.

The other (alternative B) for reforming the disability system is to maintain the old benefit levels (for those who receive them) but allow workers to earn up to $300 a month and still keep their benefits. Those who earn over $300 per month would lose all DI benefits.

e) Draw the original budget constraint and the budget constraint under alternative B.

f) Can this program increase labor supply? Explain how it possible or impossible. If possible show how graphically.

g) Can this program have no effect on labor supply? If yes show how graphically.

h) Can this program decrease labor supply? (Hint some current workers are eligible for DI but choose to work instead) Explain how it possible or impossible. If possible show how graphically.