CHAPTER 2 THEORETICAL TOOLS OF PUBLIC FINANCE 37

We can measure this income effect by the change from the government-
supported budget constraint BCg to the new budget constraint BC2. This
change represents the restriction in Andreas opportunity set at the new prices.
Since she is poorer, she chooses fewer of all goods, including both movies
and CDs, at point C. In this case, the income effect reinforces the substitu-
tion effect for movies: both cause the quantity of movies she demands to
fall.2 To sum up, when the price of one good increases relative to another,
you choose less of that good for two reasons: because it is relatively more
expensive (the substitution effect) and because you are effectively poorer
(the income effect).

2.2
Putting the Tools to Work: TANF and Labor Supply
Among Single Mothers
n your new position with the state government, you have now reviewed
I the theoretical concepts necessary to address the concerns of the secretary
and the governor. Having reviewed these theoretical concepts, lets turn to
the question posed at the start of the chapter: Will reducing TANF benefits
increase the labor supply of single mothers? To answer this question, we can
apply the tools of utility maximization to the analysis of the labor supply
decision.
The TANF program was created in 1996 by a major overhaul of the cash
welfare system in the United States. The cash welfare system distributes money
from taxpayers to low-income families (as described in much more detail in
Chapter 17). TANF provides a monthly support check to families with
incomes below a threshold level that is set by each state. In the state of New
Jersey, for example, a single mother with two children and no other source of
income will receive a monthly check for $424.3 These checks are largely tar-
geted to single-female-headed households with children, since these families
are viewed as having the worst prospects for making a living on their own.
Suppose that Joelle is a single mother who spends all of her earnings and
TANF benefits on food for herself and her children. By working more hours,
she can earn more money for food, but there is a cost to work: she has less
time at home with her children (or less time to spend on her own leisure).
Suppose that she would prefer time at home to time at work; that is, suppose
that leisure is a normal good. With these preferences, more work makes Joelle
worse off, but it allows her to buy more food.
How does Joelle decide on the optimal amount of labor to supply? To
answer this question, we return to the utility maximization framework, but
with one twist relative to the decision to purchase CDs and movies. In that

2
They have canceling effects on the demand for CDs, however, which is why demand for CDs doesnt
change in Figure 2-7. Note also that if goods are inferior, the income effect would offset the substitution
effect, rather than reinforce it.
3
U.S. Department of Health and Human Services (2004), Table 12-2.