With the rising cost of energy, the Government has decided to provide a monetary relief to...
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With the rising cost of energy, the Government has decided to provide a monetary relief to households to help with fuel bills. Assume that it is considering two alternatives. The first is a subsidy on the unit price of fuel, which for convenience we will assume to cover only Electricity. The second is a lump-sum transfer in the form of an income payment. For the case of the subsidy option, consider a representative consumer Mrs Vieja who has a monthly income of £V which she allocates between Electricity and a composite of All Other Goods. The unit price of Electricity is PE, and the unit cost of All Other Goods is 1. The subsidy available to Mrs Vieja is at a rate of s per unit of Electricity (0<s<1). Given this, diagrammatically depict in the axes outlined below: All Other Goods (£) a) i) iii) Electricity (Kw/h) the budget constraints facing Mrs Vieja both before and after the subsidy; identify the slopes of these budget constraints; draw a representative set of indifference curves showing Mrs Vieja's change in Electricity consumption following the subsidy, consistent with Electricity being a normal good. [6 marks] b) d) e) Using the concept of the equivalent variation, identify the monetary benefit of the subsidy to Mrs Vieja on your diagram. Suggestion: you will find it easier to reproduce your diagram and show the EV in isolation as this will be needed in the next part of the question [8 marks] Identify on your diagram (hint, this will be in £s) the cost of the subsidy programme to the Government i.e., how much does it cost the Government to provide the subsidy to Mrs Vieja? [6 marks] If rather than the subsidy the Go ernment gave a lump sum transfer to Mrs Vieja (i.e., they increased her income), show on your diagram the income required to have the same effect on Mrs Vieja's utility/wellbeing as the subsidy has. Reflect and comment upon this in light of the equivalent variation identified previously. [4 marks] Comparing the cost of the subsidy (from part c) and the size of the lump sum transfer (from part d), what does this tell you about the relative efficiency of subsidies relative to lump sum transfers? Intuitively, what is the reason for this finding? [6 marks] With the rising cost of energy, the Government has decided to provide a monetary relief to households to help with fuel bills. Assume that it is considering two alternatives. The first is a subsidy on the unit price of fuel, which for convenience we will assume to cover only Electricity. The second is a lump-sum transfer in the form of an income payment. For the case of the subsidy option, consider a representative consumer Mrs Vieja who has a monthly income of £V which she allocates between Electricity and a composite of All Other Goods. The unit price of Electricity is PE, and the unit cost of All Other Goods is 1. The subsidy available to Mrs Vieja is at a rate of s per unit of Electricity (0<s<1). Given this, diagrammatically depict in the axes outlined below: All Other Goods (£) a) i) iii) Electricity (Kw/h) the budget constraints facing Mrs Vieja both before and after the subsidy; identify the slopes of these budget constraints; draw a representative set of indifference curves showing Mrs Vieja's change in Electricity consumption following the subsidy, consistent with Electricity being a normal good. [6 marks] b) d) e) Using the concept of the equivalent variation, identify the monetary benefit of the subsidy to Mrs Vieja on your diagram. Suggestion: you will find it easier to reproduce your diagram and show the EV in isolation as this will be needed in the next part of the question [8 marks] Identify on your diagram (hint, this will be in £s) the cost of the subsidy programme to the Government i.e., how much does it cost the Government to provide the subsidy to Mrs Vieja? [6 marks] If rather than the subsidy the Go ernment gave a lump sum transfer to Mrs Vieja (i.e., they increased her income), show on your diagram the income required to have the same effect on Mrs Vieja's utility/wellbeing as the subsidy has. Reflect and comment upon this in light of the equivalent variation identified previously. [4 marks] Comparing the cost of the subsidy (from part c) and the size of the lump sum transfer (from part d), what does this tell you about the relative efficiency of subsidies relative to lump sum transfers? Intuitively, what is the reason for this finding? [6 marks]
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Budget Constraints and Indifference Curves for Mrs Vieja a Budget Constraints and Indifference Curves i Budget Constraints Before Subsidy Budget line ... View the full answer
Related Book For
Cost Accounting Foundations and Evolutions
ISBN: 978-1111626822
8th Edition
Authors: Michael R. Kinney, Cecily A. Raiborn
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