Consider a household that consume only two goods – food and “other goods” – that are each normal goods The income of the household is $120, the price of food is $10 and the price of “other goods” is $20. The household always consumes 50 percent of its income (or income plus value of coupon) on food and 50 percent on other things.
The government is considering three policies designed to raise food consumption. -- A transfer of $40 in cash to the household
-- A coupon that can be used only to consume 4 units of food (and costs government $40) -- A subsidy of $4/unit on food
1. How much food and “other goods” does the household consume in the initial situation?
d) 6 food, 3 other goods
2. If the government gives a transfer of $40 in cash to the household, how much food and “other goods” does the household consume?
d) 8 food, 4 other goods
3. If the government gives a coupon for 4 units of food to the household, how much food and “other goods” does the household consume?
e) Not Given
4. Between the $40 transfer and the coupon for 4 units of food, under which policy does the household consume more food?
c) Neither, consumption of food is the same d) Cannot be determined
5. If the government gives a subsidy of $4/unit on food (and there is no other transfer – i.e. income is $120) how many units of food does the household purchase?
b) 10 units
6. Under which policy does the government spend the least amount of money towards the food consumption of this household? [Note: The initial situation is not included in the comparison] a) Transfer of $40
d) None – they all cost the same
7. If the government wants the best combination of spending as little money as possible and raising the food consumption of the household as much as possible, which policy should it adopt?
c) Subsidy of $4/unit