Dominick Salvatore Schaums Outline of Microeconomics, 4th edition Schaums Outline Series 2006

CHAP. 4] CONSUMER DEMAND THEORY 97
4.39 Suppose that a “typical” poor family is in equilibrium at point A on budget line 1 and indifference curve
I in Fig. 4-33. (At this point this family spends $1000 of its income of $5000 to purchase 100 units of
food.) Suppose that now the government decides to lift this poor family’s level of utility or satisfaction
from indifference curve I to indifference curve II. (a) How can the government do this by subsidizing the
family’s consumption (i.e., paying part of the price) of food? (b) What would be the cost of this program
to the government per “typical” poor family? (c) How else could the government achieve the same
result? At what cost? (d ) Why might the government still choose the more expensive program to
achieve the desired results?
Fig. 4-33
(a) One way in which the government can lift this poor family’s level of utility or satisfaction from point A
on budget line 1 and indifference curve I to indifference curve II is by allowing this family to purchase
food at half the market price, with the other half of the market price paid by the government. With this
consumption subsidy on food purchases, this poor family would reach the new equilibrium point C on
budget line 2 and indifference curve II.
(b) To reach point C with the above program, this poor family spends $2000 of its income to purchase 400
units of food (see the figure). Without the subsidy, the family would have had to spend $4000 of its
income to purchase 400 units of food (point E in the figure). Thus, the cost of this program to the government
would be $2000 (CE) per “typical” poor family.
(c) The government could also achieve its objective of lifting this poor family’s level of satisfaction from indifference
curve I to indifference curve II by giving instead a cash subsidy of only $1500. With this cash
subsidy, the poor family would be in equilibrium at point B on budget line 1 0 and indifference curve II.
At point B, the family spends $2000 of its income (of $6500) to purchase 200 units of food (see Fig. 4-32).
(d) Even if it is more expensive, the government might still choose the first of these programs because it
results in a greater increase in this family’s consumption of food. This greater increase in the consumption
of food may itself be an aim of the government aid program.
4.40 Panels A and B of Fig. 4-34 measure money income on the vertical axis and leisure time on the horizontal
axis. Panel A shows that an individual has a maximum of 80 h per week available for either
leisure or work. The individual’s income is zero if 80 h is devoted to leisure and $400 if 80 h is
devoted to work. Point A shows the individual choosing 40 h of leisure and 40 h of work, with a
total personal income of $200 per week. Panel B shows various combinations of leisure and income
that give the individual the same satisfaction. For example, the individual is indifferent between an