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

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

“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. 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 Money Income YA LA Leisure

Two Lawyers: • Lazy Lawyer (LL) • Hardworking Lawyer (HL) Money Income 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? A Leisure

Money Income LL HL A Leisure

Money Income LL HL A UHL ULL Leisure

Money Income (–) (+) Loss in Utility due to less Income Gain in Utility due to more Leisure Rearranging, Marginal rate of substitution between leisure and money income A B U1 Leisure

slope of indifference curve Money Income Marginal rate of substitution between leisure and income (MRS) ratio of MU with the MU of the good on the horizontal axis in the numerator. A B U1 Leisure

Budget Constraint Assumptions: • 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

slope Money Income ($ per day) slope slope YW T 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.

The Labor Force Participation (LFP) Decision Money Income ($ per day) UHL slope ULL T Leisure (hours per day)

Money Income ($ per day) L=Lazy H=Hardworking UH UL Leisure (hours per day)

A UL T=16

Brendan’s Labor Force Participation Decision (LFPD) A Do not participate MRS | =T 2w UL Participate MRS | =T 2w T=16

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.

Money Income ($ per day) Leisure (hours per day)

Money Income ($ per day) UL UL Leisure (hours per day)

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.

Money Income ($ per day) slope U1 T Leisure (hours per day)

Money Income ($ per day) slope U1 U2 T Leisure (hours 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.

Money Income ($ per day) slope slope U1 T Leisure (hours per day)

Money Income ($ per day) Wage Effect with the Income Effect Dominating slope slope U2 U1 T Leisure (hours per day)

Money Income ($ per day) slope slope U1 T Leisure (hours per day)

Money Income ($ per day) Wage Effect with the Substitution Effect Dominating slope U2 slope U1 T Leisure (hours per day)

Money Income ($ per day) slope U2 slope U1 T Leisure (hours per day)

Hypothetical budget constraint—original utility, new wage Money Income ($ per day) The substitution effect: to The income effect: to slope U2 slope U1 T Leisure (hours per day)

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