“What can be the matter? No misfortune at home, I hope?”

transcript

• “What can be the matter? No misfortune at home, I hope?”

• “No; but I have just heard something that has shocked me very much. There is an execution at Dale’s.”

• “How hard that poor man has struggled!” observed Mr. Burke. “And has it even come to this at last?”

• “Even so; and through no fault of his own that I can see. They are distraining for the rate.”

• “Aye, that is the way Effingham. Thus is our pauper list swelled, year by year. It grows at both ends. Paupers multiple their own numbers as fast as they can, and rate-payers sink down into rate-receivers.”

Harriet Martineau, Cousin Marshall, 1834

Mr. Burke, a character in Harriet Martineau’s short story Cousin Marshall, sees his friend, Mr. Effingham, looking unhappy. Mr. Burke asks,

“Aye, that is the way Effingham. Thus is our pauper list swelled, year by year. It grows at both ends. Paupers multiple their own numbers as fast as they can, and rate-payers sink down into rate-receivers.”

Harriet Martineau is talking about paupers choosing not to work because of the English poor laws and taxpayers being driven to bankruptcy because of their cost.

In other words, she is talking about the work disincentive effects of the English poor laws.

It can be challenging to give people money without eroding the incentive to work and be independent. It’s true for welfare recipients, boomerang kids, and the children of millionaires and billionaires. The perfect amount to leave children, according to Warren Buffett, is “enough money so that they would feel they could do anything, but not so much that they could do nothing.”

Incentive trusts put “strings” on the distribution of inheritances, making payments conditional on recipients’ behavior, often rewarding offspring who graduate from college, work in the labor force, get married or refrain from using drugs.

Brendan Wood is currently 23 years old. When he was 17 years old, his wealthy parents, Sean and Nora, encouraged him to save money from his lifeguard job at a water park by promising to match his savings dollar for dollar. Suppose Brendan’s parents died unexpectedly three years later, after having designed an incentive trust to reward Brendan if he completed college and worked steadily in the labor market. After graduating from college, he bought a beach house, Porsche and Jeep with his “college bonus.” He is an promising, although inexperienced programmer, leading him to be offered a job with a software company where he would be paid $25 an hour for as many hours as he wanted to work. His trust fund pays him $200 per day and an additional dollar for every dollar he earns; every year the trust fund also donates substantial amounts of money to charity.

(a) Illustrate Brendan’s choice of whether or not to accept the job, assuming first that he accepts it and then doesn’t.

Labor / Leisure Choice

Indifference curves: all combinations of leisure and income that yield equal utility.

MoneyIncome

Leisure

Properties of Indifference curves

• indifference curves are downward sloping

• indifference curves do not intersect• higher indifference curves are associated

with higher levels of utility• indifference curves are [strictly] convex

to the origin

Leisure

L 𝐴

MoneyIncome

Two Lawyers:

• Lazy Lawyer (LL)

• Hardworking Lawyer (HL)

LL and HL are both currently at point A. Which lawyer would need more income to compensate him or her for losing one unit of leisure?

Leisure

L 𝐴

MoneyIncome

Y𝐻𝐿

Y𝐿𝐿

L 𝐴− 1

Leisure

L 𝐴

MoneyIncome

Y𝐻𝐿

Y𝐿𝐿

L 𝐴− 1

Leisure

∆ 𝑌<0

∆ L>0

𝑀𝑈𝑌 ∙ ∆𝑌(–)

Loss in Utility due to less Income

𝑀𝑃 L∙ ∆ L(+)

Gain in Utility due to more

Leisure

+¿ ¿0

Rearranging,

∆𝑌∆ L

=−𝑀𝑈 L

𝑀𝑈𝑌

MoneyIncome

Marginal rate of substitution between leisure and money income

Leisure

∆ 𝑌<0

∆ L>0

MoneyIncome

∆𝐾∆ 𝐿=−

𝑀𝑃𝐿

𝑀𝑃𝐾

slope of indifference curve

ratio of MU with the MU of the good on the horizontal axis in the numerator.

Marginal rate of substitution between leisure and income (MRS)

Budget ConstraintAssumptions:

• Total discretionary time (T) = 16 hours per day

• Market Labor (L) or Leisure (L), ignoring, for now, home production

• Money Income = Earnings + Non-Labor Income (YW)

• w =$25 per hour• YW=$200 per day• Trust: $ for $ match of w

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 180

MoneyIncome

($ per day)

Leisure(hours per day)

Brendan Wood is currently 23 years old. When he was 17 years old, his wealthy parents, Sean and Nora, encouraged him to save money from his lifeguard job at a water park by promising to match his savings dollar for dollar. Suppose Brendan’s parents died unexpectedly three years later, after having designed an incentive trust to reward Brendan if he completed college and worked steadily in the labor market. After graduating from college, he bought a beach house, Porsche and Jeep with his “college bonus.” He is an promising, although inexperienced programmer, leading him to be offered a job with a software company where he would be paid $25 an hour for as many hours as he wanted to work. His trust fund pays him $200 per day and an additional dollar for every dollar he earns; every year the trust fund also donates substantial amounts of money to charity.

(a) Illustrate Brendan’s choice of whether or not to accept the job, assuming first that he accepts it and then doesn’t.

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 180

MoneyIncome

($ per day)

The Labor Force Participation (LFP) Decision

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 180

MoneyIncome

($ per day)

L=LazyH=Hardworking

L𝐻𝐿𝐻=𝑇 − L𝐻=9

Slope at ABudget constraint -2w

Indifference curve -MRS

ABrendan’s Labor Force

Participation Decision (LFPD)

MRS | =T 2wDo not

participate

MRS | =T 2w Participate

How could Sean and Nora have increased the likelihood that Brendan would work after graduating from college?

• Increase the wage… pure substitution effect

• Reduce the daily stipend, assuming that leisure is a normal good.

and / or

Suppose Sean and Nora had written the incentive trust differently, giving Brendan a stipend of $100 per day and giving him $5 for every $1 of earnings. Illustrate Brendan’s labor force participation decision before and after the change, assuming that the change would have induced him to work.

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 180

MoneyIncome

($ per day)

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 180

MoneyIncome

($ per day)

L𝐻𝐿𝐻=𝑇 − L𝐻=3

The Hours of Work Decision

• On a beautiful Southern California morning, Brendan drove his Porsche up the Pacific Coast Highway, stopping for lunch at a café overlooking the ocean. After finishing his bean salad (with walnuts and feta), he opened up Dreaming in Code, flipped to the first page and started reading.

• The story begins when the author was 15 years old and spending gobs of time in NYU’s computer labs, free-coding on their dime. Even then, the guy was passionate about writing code: he thought about it constantly, even dreamt about it. Brendan thought about the time he spent in UCLA’s computer labs—he remembered being obsessed with many of his programs, although he couldn’t remember ever dreaming in code. It was a good time in his life, especially when he was together with Meghan.

• After reading the first chapter, Brendan flipped back to the beginning and looked at its title, Software Time. He suddenly felt empty, living a life without purpose, alone without Meghan. “Software time, Meghan time,” he thought, “ran out for me when I left UCLA.”

• It was an epiphany, one that radically altered his indifference curves between leisure and labor—he went from being a leisure-loving, beach bum to a labor-loving, lab nerd. Driving back to LA along the Pacific Coast Highway, he called a couple of friends who majored in computer science and, with his heart pounding, Meghan.

A few days later, Brendan called the trustee of his trust fund to tell her to donate his daily stipend of $200 per day to the Halo Trust, both because he believed in its mission—clearing Africa of land mines—and because he knew it would strengthen the work incentive effects of his trust fund. Illustrate how he reacted to the change, assuming that leisure is a normal good.

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 180

MoneyIncome

($ per day)

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 180

MoneyIncome

($ per day)

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 180

MoneyIncome

($ per day)

Illustrate the income and substitution effects of the provision of Brendan’s trust fund that gives him a dollar for every dollar of earnings holding the stipend constant at $200 per day.

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 180

MoneyIncome

($ per day)

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 180

MoneyIncome

($ per day)

Wage Effect with the Income Effect Dominating

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 180

MoneyIncome

($ per day)

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 180

MoneyIncome

($ per day)

Wage Effect with the Substitution Effect Dominating

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 180

MoneyIncome

($ per day)

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 180

MoneyIncome

($ per day)

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 180

MoneyIncome

($ per day)

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 180

MoneyIncome

($ per day)

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 180

MoneyIncome

($ per day)

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 180

MoneyIncome

($ per day)

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 180

MoneyIncome

($ per day)

Hypothetical budget constraint—original utility, new wage

The substitution effect: L1to L3

The income effect: L2to L3

“What can be the matter? No misfortune at home, I hope?”

Documents