Question

Consider someone who has an income of $100 and consumes food and other goods.

The two goods are measured so that the prices are each $1.00. Depict the budget constraint on a

graph with food on the horizontal axis and other goods on the vertical axis. What are the intercepts

and the slope? Now suppose the government is considering a transfer program to encourage people

to consume more food.

Specifically, the government offers 20 units of food for free. Suppose the 20 units of food cannot be

resold. How does this program change the budget constraint? What is the maximum number of

units of food the family can consume? What is the maximum number of units of other goods the

family can consume? Is the program a subsidy-in-kind or is it equivalent to a cash grant? (Hint:

Does the answer to this question depend on the consumer’s preferences?)

Answer 1

The question tries to differentiate between different transfer methods by government i.e. subsidy or cash grant. A subsidy in kind allows the consumer to consume more of the specific commodity it is provided for. It is like the government directing you to consume more of a particular commodity by subsidising it. A cash grant on the other hand allows you to freely choose between the choices available to you and spend your money as per your own discretion.

Hence, it depends on the consumer preferences ultimately if we have to say whether the program is cash grant equivalent or subsidy equivalent.

Income = $100 perc = $1 Porner Quests = $1 Budget constraint Bc) is therefore PCB + Pa (A) = 100 othly Good Ft G-100 AB is our Budget anstraint. Intencipts are (Choo) on y axis 100,0) on x-axis i.e. The maximum that we can wonsume food is 100% and similarly the man amount of other goods that we can consume is 100/1 > 100 20 40 60 PO 106 120 sfeed slope of Budget tone : la = Prood - I l Goods Given a transfer program , boudinmont offeru 20 units al food for free , which can not be resold. This will hit the budget line outward parallely such that the maximum amount of food that is available to the Consumer 100 Suffrue) 11&p units ! But since these units can be resold , therefore the man ne can spend on other goods is still $100 hence the new Budget ine Has a kink : ACD max units of Food : 120 Other Goods :lool The programme acts like a subsidy in kind if the Prefecinies of consumers are such that He consumes on cci portion of the new Budget line which is not affordable to sim. in such a case He'll consume on the kink, at c. But if preferences are such that he consumes on co part af Budget line, then transfer acts as a cash Grant