Part (d) (10 points)

Reproduce your diagram from part (c). Suppose that the household were offered Plan 2 instead of Plan 1. Would the household be better off, worse off, or indifferent? Support your answer by doing further diagrammatic work and providing explanations.

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Suppose that a typical household has $180 monthly income to spend on fuel and other goods. Assume that the price of fuel per litre is $1.80 and the price of a unit of other goods is $1. The household has usual shaped strictly convex preferences between fuel and other goods. Suppose that a typical household chooses to purchase 50 litres of fuel and 90 units of other goods with their monthly income. As fuel prices increase due to the recent global crisis, the government is planning to impose a new policy to reduce the cost-of-living pressures on the households. You have been asked to analyse the following two policies designed for this purpose. Plan 1. The government imposes a fuel excise tax cut so that the fuel price is reduced by 50%, i.e., the price of fuel per litre becomes $0.90. Plan 2. The government increases the income of the household by 50%, i.e., the income of the household becomes $270. ¹ For example, the Australian government imposed a fuel excise tax cut by halving the excise tax for six months starting in March 2022. Please keep litres of fuel on the horizontal axis and units of other goods on the vertical axis while drawing diagrams. Assume that the bundle purchased by the household is the optimal one. Suppose that a typical household has $180 monthly income to spend on fuel and other goods. Assume that the price of fuel per litre is $1.80 and the price of a unit of other goods is $1. The household has usual shaped strictly convex preferences between fuel and other goods. Suppose that a typical household chooses to purchase 50 litres of fuel and 90 units of other goods with their monthly income. As fuel prices increase due to the recent global crisis, the government is planning to impose a new policy to reduce the cost-of-living pressures on the households. You have been asked to analyse the following two policies designed for this purpose. Plan 1. The government imposes a fuel excise tax cut so that the fuel price is reduced by 50%, i.e., the price of fuel per litre becomes $0.90. Plan 2. The government increases the income of the household by 50%, i.e., the income of the household becomes $270. ¹ For example, the Australian government imposed a fuel excise tax cut by halving the excise tax for six months starting in March 2022. Please keep litres of fuel on the horizontal axis and units of other goods on the vertical axis while drawing diagrams. Assume that the bundle purchased by the household is the optimal one.

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