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Public Finance ( MPA405 ). Dr. Khurrum S. Mughal. Lecture 16: Government Subsidies and Income Support for the Poor. Public Finance. Economic Analysis of the Effects of Government Transfers. Effect on Resource allocation Consumer may consume where MSB is less that MSC

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Public finance mpa405

Public Finance (MPA405)

Dr. Khurrum S. Mughal


Lecture 16 government subsidies and income support for the poor

Lecture 16: Government Subsidies and Income Support for the Poor

Public Finance


Economic analysis of the effects of government transfers

Economic Analysis of the Effects of Government Transfers

  • Effect on Resource allocation

  • Consumer may consume where MSB is less that MSC

  • Loss of willingness to work if after work income is less

  • Analysis highlights the equity-efficiency trade-off


Price distorting subsidies

Price Distorting Subsidies

  • Price Distorting Subsidies lower the price of the particular good relative to others for eligible people.


Price distorting subsidies1

Price Distorting Subsidies

  • Example of Housing subsidy

    • Hiring apartment at below the market rent

    • Govt pays the difference

  • Subsidized Mortgage loans


A price distorting subsidy

A Price Distorting Subsidy

L

I

E3

N3

E1

N1

E2

Expenditure on Other Goods

per Month (Dollars)

N2

U3

U1

U2

Subsidy

S

H1

H2

H3

A

L'

0

B

Housing Services per Month


Price distorting subsidies2

Price Distorting Subsidies

  • Implications:

    • Induces to purchase a larger amount of housing that he/she would normally do

    • Higher level of utility in presence of cash grant equal to the subsidy

    • Spending on other goods can also be increased

    • Dead weight loss

      • Difference between E2 and E3


Price distorting subsidies and market effects

Price Distorting Subsidies and Market Effects

  • Example of Housing Market

  • Operates on constant cost

  • Long run supply curve is perfectly elastic

  • Government agrees to pay half the rent


Excess burden of a subsidy market effects

Excess Burden of a Subsidy: Market Effects

Excess Burden of Subsidy

S = MSC

S’

D = MSB

B

E

A

400

Rent (Dollars per Month)

C

F

E’

200

0

Q1

Q2

Number of Apartments Rented


Dead weight loss or excess burden

Dead Weight Loss or Excess Burden

  • Dead Weight Loss (sometimes called Excess Burden ) is the measure of the dollar value of the distortion that exceeds the amount transferred to the recipient.


Implications

Implications

  • Induces low-income people to increase their consumption – increased demand

  • More resources are allocated for building more houses

    • But value exceeds the benefits

    • Important to compare costs to tax payers and the benefits accruing to low income tenants


Implications1

Implications

  • Cost of Subsidy to tax payers

    • $200 multiplied by increase in apartments rented after subsidy Area BAE`C


Excess burden of a subsidy market effects1

Excess Burden of a Subsidy: Market Effects

Excess Burden of Subsidy

S = MSC

S’

D = MSB

B

E

A

400

Rent (Dollars per Month)

C

F

E’

200

0

Q1

Q2

Number of Apartments Rented


Implications2

Implications

  • Benefits to Low Income Tenants

    • Those who would rent one bedroom apartment even without the subsidy.

      • $200 multiplied by Q1 (Area BEFC)

    • Those who would rent after the subsidy. Net benefit would be the difference between MB they assign to housing and $200 (Area EE`F)


Excess burden of a subsidy market effects2

Excess Burden of a Subsidy: Market Effects

Excess Burden of Subsidy

S = MSC

S’

D = MSB

B

E

A

400

Rent (Dollars per Month)

C

F

E’

200

0

Q1

Q2

Number of Apartments Rented


Implications3

Implications

  • Total Benefit: Area BEFC + EE`F

  • Total Cost: Area BAE`C

  • So the cost is greater than the benefit and there is excess burden


Price distorting subsidies that lowers the price to zero

Price Distorting Subsidies that Lowers the Price to Zero

  • Medicaid – Largest program of assistance to Poor in USA

  • Reduced the cost of medical services to “zero”

  • Assuming annual quantity of medical care consumed can be measured by number of hospital visits

  • Supplied by perfectly competitive industry

  • MSC doesn’t increase when more is made available


Full subsidization of medical services

Full Subsidization of Medical Services

B

E1

A

25 = P*

Price (Dollars per Month)

Excess Burden

MBL

E2

Q*

QG

0

Medical Office Visits per Year


Implications4

Implications

  • Increase in Consumer Surplus

  • Part of increase is already what would have been acquired anyway

  • Excess burden is the due to subsidy in kind

  • Medicaid recipients would be better off with cash subsidy


Additional effects of subsidies the case of increasing costs

Additional Effects of Subsidies: The Case of Increasing Costs

  • Medicaid not only costs taxpayers money to pay for the program, it also increases the amount they pay for medical services by increasing demand for those services.


The impact of the medicaid program on price the case of increasing cost

The Impact of The Medicaid Program on Price: The Case of Increasing Cost

S = MSC

D'

M

DM = MSB

DO

DL

Q'

O

E2

140

Price (Dollars)

E1

100

QL

QO

QI

QG

Q2

0

Medical Office Visits per Year


Implications5

Implications

  • Increase in Prices of Medical Services

  • Tax payers finance the program

  • Tax payers face the higher medical service prices for themselves

  • Overall decrease in real incomes of tax payers

  • Losses in efficiency as well as changes in income distribution


Subsidizing housing

Subsidizing Housing

  • Providing an Apartment: This subsidy allocates a standard apartment to an eligible recipient. With this type of subsidy the recipient cannot supplement the subsidy with their cash. It is a “take it or leave it” option.

  • Housing Vouchers: This subsidy allows the recipient a particular allotment of vouchers to rent housing but the recipient may supplement the subsidy with their cash.

  • Cash: This subsidy is not restricted to spending on housing.


Public housing

Public Housing

  • Government constructed low cost housing for low income families

  • Rented at well below market rates

  • Public Housing are expected to increase recipient's housing consumption

  • Might reduce housing consumption due to lack of freedom of choice

  • Suppose Government offers housing at $30 per room where the rent for 3 bedroom apartment is 90 $

    • The same goes for rent in the market for $300


Eligibility for public housing and the effect on housing consumption

Eligibility for Public Housing and the Effect on Housing Consumption

I'

800 = I

210

90

G

M

210

E2

Expenditure on Other Goods

per Month (Dollars)

H

J

400= F

E1

U3

U1

U2

A

B

0

1

2

3

4

5

6

7

Housing per Month (Number of Rooms Rented)


Refusing a public housing subsidy

Refusing a Public-Housing Subsidy

I

G

M

E1

J

U2

U3

Expenditure on Other Goods

per Month (Dollars)

0

1

2

3

4

5

6

7

A

Housing per Month (Number of Rooms Rented)


Subsidizing food

Subsidizing Food

  • Food Stamps are the subsidy that allows the recipient a particular allotment of vouchers to buy food but the recipient may supplement the subsidy with their cash. It is illegal to sell the food stamps though it may be in the recipients interests for them to do so.


The impact of an in kind transfer food stamps

The Impact of an In-Kind Transfer: Food Stamps

E1

C

C

E2

E1

E1

Q*

1

A

B

B

B

F

L

I

I

U3

Expenditure on Other Goods

per Month (Dollars)

M1

U2

M2

U1

M1

U2

U1

QF

0

QF

QF1

QF2

A

A'

0

QF2

QF1

A

A'

Food per Month


The impact of government assistance programs on work

The Impact of Government Assistance Programs on Work

  • Transfers could cause people to work more or less depending on whether leisure is a normal good.


International food subsidies

International Food Subsidies

  • Several nations use a price-reducing subsidy to make food more affordable.

    • Programs that reduce the price of food benefit higher-income people as well.

  • Some nations only subsidize food that is typically consumed by the poor.

  • Some nations distribute food directly.


The income effect of a transfer

The Income Effect of a Transfer

U3

U2

G

U1

E2

E1

D

Transfer

Payment

F

C

E3

A

Income per Day

0

L1

L2

24

Leisure Hours per Day


A transfer that declines with earned income e g t 300 7i e

A Transfer that Declines with Earned Incomee.g. T=$300-.7IE

A

C

E2

U2

E1

D

U1

Maximum

Daily

Transfer

B

Income per Day

L*

L1

L2

24

Leisure Hours per Day


Empirical evidence

Empirical Evidence

  • A 10% increase in welfare payments to individuals decreases work effort by 2%.


A negative income tax

A Negative Income Tax

  • A Negative Income Tax is a system where there is no status test but there is an income guarantee and a take-back rate.

  • T = IG– tNIE

    Where

  • IG= Income guarantee

  • tN= take back rate

  • IE= earned income

  • T = Transfer


Break even income

Break-Even Income

0 = IG– tNIB

IB= IG/tN


Negative income tax

Negative Income Tax


Wage rate subsidies

Wage Rate Subsidies

  • Wage Rate Subsidies are government additions to wages designed to increase the pay of the working poor.


Wage rate subsidies1

Wage Rate Subsidies


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