Explain the Moral Hazard Costs of Welfare Policy. Moral Hazard Effects of a Means - Tested Transfer System.

Arthur Okun once compared the process of income redistribution to a “leaky bucket”: we are carrying money from the rich to the poor, but some money leaks out along the way. There are three sources of leakage from Okun’s bucket as society transfers money from high- to low-income groups. The first is the administrative costs of enabling this transfer, which are fairly modest (roughly 10% of total TANF spending). The second leakage occurs because higher income individuals are taxed to pay for income transfers. This taxation lowers returns to work and savings and might cause higher-income people to work less hard or save less. The third source of leakage is the moral hazard effects on the poor individuals who are potential recipients of these transfers. As the government insures individuals against being poor, it raises the incentive for individuals to be poor in order to qualify for these transfers, raising the cost of these means-tested transfers.

Means-tested transfer system is a simplified version of TANF or other redistributive programs, but it allows us to clearly show the effects of moral hazard that come with redistribution. Under this system, the government would guarantee every individual an income transfer (the benefit guarantee), but this transfer would be reduced as labor earnings increase, at the benefit reduction rate (the implicit tax rate). By providing income transfers to low-income groups, the program makes being low- income more attractive, encouraging individuals to work less hard. This moral hazard effect reduces the labor supply of low-income groups.

Most arguments for government funding of medical care rest on equity concerns. Explain how medical care can be a public good. If medical care is a public good, explain how this would lead to a market failure in that individuals would receive less medical care than is efficient.

Government plays an important role in the various medical markets and either directly or indirectly influences the health of the population in a number of ways. For example, regulatory and taxing policies affect the production or consumption of certain products (such as prescription drugs, narcotics, alcohol, and tobacco) and thereby beneficially or adversely affect the population's health.
The public policy and current political action around changing the system overlooks two important technical fallacies:(1) That health care is most efficiently distributed by a free market mechanism; and,
(2) That medical services are an ordinary commodity.
The commercial market model is a failing economic and public policy ideology used to rationalize and justify corporate control of the health care system to profit from the enterprise. Medical services are not an ordinary commodity but more like a “public good” which should be financed using a regulated public utility model.
A “public good” is a product or service which benefits everyone in the community. Public goods are characterized by: (1) value that has benefit to the community as a whole beyond any purchase price paid, (2) often requiring large initial investment costs that are generally too expensive for any individual or private corporation to afford and earn a reasonable return, (3) requiring a higher level of administration than any individual or company can arrange and (4) having value that accrues over time and is difficult to price properly. Public goods have “externalities,” that is, value that accrues to people who benefit by other’s consumption of them without paying for it themselves.
There are two separate reasons to intervene, market failure and equity. Taking market failure first, there are a variety of failures in health care and insurance markets such as asymmetric information, market power, and principal agent problems. These can be solved by the private sector in some cases, but in others government intervention is required. But even if the private sector or the government can solve the market failure problems adequately, there's no guarantee that the resulting distribution of health care services will be equitable. We don't expect the private sector to, for example, make sure that everyone can live on the coast and have an ocean view if they so desire, we use market prices to ration those goods, but we may want to make sure that everyone can get health care when they have serious illnesses. So equity considerations may prompt the government to intervene and bring about a different distribution of health care services than would occur with an efficient market. Both reasons, equity and efficiency, can justify government intervention into health care markets. I think equity is of paramount importance when it comes to health care, so for me that is enough to justify government intervention, and the existence of market failure simply adds to the case that government intervention is needed.

3.Explain the Crowd -Out Problem in Education. How would this "solve" with the Educational Vouchers? How vouchers will lead to excessive school specialization or to Segregation?

Problem with the system of public education provision is that it may crowd out private education provision. Providing a fixed amount of public education can actually lower educational attainment in society through inducing choice of lower quality public schools over higher-quality private schools. One solution to the crowd -out problem would be the use of educational vouchers, whereby parents are given a credit of a certain value (for example, the average spending on a child of a given age in the public education system) that can be used toward the cost of tuition at any type of school, public or private. The first argument in favor of vouchers is that vouchers allow individuals to more closely match their educational choices with their tastes. The second argument in favor of vouchers is that they will allow the education market to benefit from the competitive pressures that make private markets function efficiently. Supporters of vouchers note that, in fact, vouchers may serve to reduce the natural segregation that already exists in our educational system. Vouchers allow motivated students and their parents to choose a better education and end the segregation imposed on them by location. At the same time, vouchers might increase segregation by student skill level or motivation.

1.b

2.a

3.c

4.d

5.d

6.c

7.b

8.e

9.a

10.a

3.1. Workers may work longer if their best 40 years counted rather than their best 35. Generally, you would expect earned income to increase over a worker’s lifetime; thus, the last several years are likely to yield higher income than the first several years. Being able to count 5 more high- earning years would induce some workers to remain in the workforce to increase their calculated benefits; if they did not work longer, the 40 years might include some very low or zero-earning years (when the worker was in his or her twenties, possibly still in school). The primary reason this bill would tend to increase the Social Security trust fund is because it would tend to reduce the Averaged Indexed Monthly Earnings and therefore the size of retiree benefits. Simply put, the 5 additional years of earnings history would be the lowest five years counted (or else they would have been counted in the original 35). This effect might be partially offset by workers tending to work more (high earnings) years. Of course, these additional years of work would also involve Social Security payroll taxes that would increase the trust fund.

3.2. To answer these questions, first rewrite each demand so that P is expressed as a function of Q: Alfie: P A = 11 – 0.2 Q; Bill: P B = 20 – 0.25 Q; Coco: P C = 10 – 0.1 Q. Adding each person’s willingness to pay yields P A + P B + P C = 41 – 0.55 Q. The left- hand side gives the marginal social benefit of providing the Q th unit of the good. Setting this marginal benefit equal to the marginal cost gives the socially optimum level of provision: 41 – 0.55 Q = 13.5, or Q = 50 When Q = 50, Alfie’s marginal benefit is 11 – 0.2(50) = 1. Similarly, Bill’s marginal benefit is 20 – 0.25(50) = 7.5, and Coco’s is 10 – 0.1(50) = 5. Hence, Alfie’s share of the tax burden under Lindahl pricing is 1/13.5 ≈ 7.4%, and Bill and Coco’s shares are approximately 55.6% and 37%, respectively.

VARIANT 7