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Problem on Infrastructure

The state legislature has voted to develop a grant-in-aid policy to try and induce local communities to devote more resources to improving their infrastructure.

Town O = Has an operating budget of $2 million; currently spends a total of $60,000 on infrastructure
Town M = Has an operating budget of $1 million; currently spends a total of $10,000 on infrastructure

Assume that for each community:

• The price for a unit of infrastructure (I) = $1
• The price for a unit of any other good (AOG) = $1

The state is considering is providing each community with a $40,000 non-matching, categorical grant that can be used only for infrastructure. Predict how this grant would affect the total amount of money Town O spends on infrastructure. 

In your answer, be sure to show in a clearly labeled diagram for Town O only: (a) the original budget line (without grant); (b) the original spending on infrastructure and AOGs without grant; (c) the new budget line (with grant); (d) the range of plausible values for Town O’s spending on infrastructure after the grant.

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