Use a labor-leisure choice model such as that developed in Chapter 12 to analyze the incentive effect of government program targeted at low-income households. Suppose, in particular, that the government provides a grant g0 for households with income less than some threshold y0. Once household income reaches the threshold y0, however, the household is not longer eligible for the grant and receives nothing.
a. Draw the household budget line and analyze the work incentive effect of the government grant program.
b. Suppose, instead, that the lump-sum grant of g0 is reduced as household income rises, with the grant formula: g = g0 – gy y. The term gy is the marginal rate at which the grant is reduced as income increases. Once income reaches the level y = g0 / gy the household no longer qualifies for the grant and receives nothing. Draw the budget line under this grant program and explain the work incentive effects of the grant program.