Question

Your government desires that the poor in your economy eat more French Vanilla Ice Cream (a healthy protein supplement).  So it taxes the rich and gives the tax revenues as a $20.00 per-month subsidy to each poor person with which she/he MUST spend on this ice cram flavor.
 
 (a)With the price of "all other goods (AOG)" at $1.00 per unit and the price of French Vanilla Ice Cream at $1.00 for dollar each carton, show how a typical poor person with an income of $100 per month might buy all other goods and apples before the subsidy and after the subsidy.
 
(b) Now, on the same diagram, show from a micro-theory standpoint, how the typical poor person would be better off if she/he were given the $20.00 straight out rather than being forced to buy ice cream.
 (c)What is the theory trying to tell us when we say that the typical poor person would be "better off" with the $20.00 cash?
 
 (d) Often we hear the argument that we should not just give money to the poor because they will just buy alcohol and other intoxicants in order to forget their misery.  Does this position make any sense, and what does it say about the poor being "better off" with cash payouts?

Answer 1

a) There are two goods (AOG) and ice creasm C. The prices are $1.00 per unit for each. Income is $100. Hence the initial budget is 100 = AOG + C where the intercepts are A = 100 AOG, B = 100 IC and budget line is AB. After receiving a subsidy of $20 only for IC, the intercept for AOG is unchanged at A but that of IC changes at D where 20 more units of IC are now consumed. The new budget is CD where the consumer can now afford 20 units of ice cream even when they are spending all $100 on AOG.

(b) If he is given a $20.00 straight out then the budget shifts outwards to ED where EC provides new bundles that were not available before.

c) When we say that the typical poor person would be "better off" with the $20.00 cash, we are saying that the consumer has now a budget set which is now available and which was not available before. This additional budget set is the area shown by EAC.

(d) Often we hear the argument that we should not just give money to the poor because they will just buy alcohol and other intoxicants in order to forget their misery. This is quite true because we as policymakers want people to increase their consumption on some specific goods and not all the goods. If cash is given, they have a probable chance to spend the budget increase on the consumption of their most preferred commodity which could be anything.

Rather than giving cash subsody, help such as food stamps, of in-kind subsidies are helpful in directing the consumption towards specific goods

Budget constraint and subsidy 120 E 100 80 O 60 40 20 0 0 20 40 60 80 100 120140 Ice cream Budget constraint Budget constraint with subsidy