Reference no: EM131372679

1. Consider a consumer who consumes two goods: education (e) and money (m) spent on all other goods.  The price of education is 50 while the price of money is 1.  Her income is 10,000.

a. Write her budget constraint and draw the budget line in a diagram with education as the horizontal axis and money as the vertical axis. 

Suppose the government would like to increase the "welfare" of this consumer by subsidizing education.

b. Consider first the proposal that increases her income from 10,000 to 15,000 (for example, by introducing a program like the earned income tax credit).  Let's call this policy as the cash transfer program.  Write her new budget constraint and draw the new budget line in a diagram similar to a.

c. Consider an alternative program that simply gives the consumer 100 units of education (for example, the Pell grant program that provides grants that can be spent only on education).  Let's call this as the in-kind transfer program.  You might have noticed that the two programs have the same cost.  Write the consumer's new budget constraint in this case and draw the budget line in a diagram.

d. Draw the budget lines for the above two programs in the same education-money diagram.  Your answers to the questions below will rely on this diagram. 

d1. Illustrate a case in which the consumer's rational choices from the two programs are the same (so that the consumer is equally well-off under the cash transfer and in-kind transfer program).

d2. Illustrate a case in which the consumer's rational choice from the cash transfer program lies on a higher indifference curve than her rational choice from the in-kind transfer program (so that she prefers the cash transfer to the in-kind transfer program).

d3. Argue that her rational choice from the in-kind transfer program cannot lie on a higher indifference curve than her rational choice from the cash-transfer program.