1. Public choice of unemployment benefits Suppose individuals face a probability of u that they will be unemployed next year. If they are unemployed they will receive unemployment benefits of b ,...

1. Public choice of unemployment benefits Suppose individuals face a probability of
u
that they will be unemployed next year. If they are unemployed they will receive unemployment benefits of
b, whereas if they are employed they receive
w
(l
–
t), where
t
is the tax used to finance unemployment benefits. Unemployment benefits are constrained by the government budget constraint
ub
=
tw
(l – u).

a. Suppose the individual’s utility function is given by
U
= (yi
)δ/δ, where 1 – δ is the degree of constant relative risk aversion. What would be the utility-maximising choices for
b
and
t?

b. How would the utility-maximising choices for

b
and
t
respond to changes in the probability of unemployment,
u?

c. How would
b
and
t
change in response to changes in the risk aversion parameter δ?