Question

1. EXTRA CREDIT: Assume a typical poor individual has enough income, given price of product X and the price of product Y to buy any of the combinations of Product X and Product Y depicted by points on BCC-2. But given their Indifference Curves, they choose to buy the combination depicted by point E-2. Now assume some people want individual to buy more of product X, and has a law passed to lower the price of product X for this typical poor individual through a subsidy program where the subsidy has to be spent on product X. This, in essence shifts their Budget Constraint to BCC-1. Now the typical poor individual can buy any of the combinations depicted points on Budget Constraint Curve 1. Given their indifference curves the individual will choose to buy the combination depicted by point E-1. Hence te subsidy would increase the consumption or product X from TX to 16X, and the person's utility would increase from IC-2 to IC-1. Prove that had the Government simply given the person enough of an increase in income to purchase 16 X and and allowed the person to spend this extra income on what they choose, they would have greater utility quantity of a composite of other products Y, the individual could be spending their income on 28 Y

Answer 1

If government had given money instead of the subsidy program, then budget line will shift upwards and consumer will move to a higher indifference curve. This can be depicted in the graph below: