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INCOME AND SUBSTITUTION EFFECTS : APPLICATIONS

INCOME AND SUBSTITUTION EFFECTS : APPLICATIONS. AN INCREASE in INCOME v . A SUBSIDY on ONE PRODUCT ONLY. Involves equal cost to the government Example : food stamps used in the US for welfare recipients (Ireland: television licence, electricity, transport, … ) .

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INCOME AND SUBSTITUTION EFFECTS : APPLICATIONS

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  1. INCOME AND SUBSTITUTION EFFECTS:APPLICATIONS

  2. AN INCREASE in INCOME v. A SUBSIDY on ONE PRODUCT ONLY • Involves equal cost to the government • Example: food stamps used in the US for welfare recipients (Ireland: television licence, electricity, transport, … )

  3. AN INCREASE in INCOME v. A SUBSIDY on ONE PRODUCT ONLY Budget constraint is given by The government can (1) give a subsidy on food (x1) Note: Equal cost to the government (2) give a increase in income

  4. AN INCREASE in INCOME v A SUBSIDY on ONE PRODUCT ONLY But which makes the consumer better off ? X2 A U0 X1

  5. AN INCREASE in INCOME v A SUBSIDY on ONE PRODUCT ONLY But which makes the consumer better off ? X2 The subsidy on food leaves the consumer at B (better off than at A) B A U1 U0 X1

  6. AN INCREASE in INCOME v A SUBSIDY on ONE PRODUCT ONLY But which makes the consumer better off ? X2 The subsidy on food leaves the consumer at B (better off than at A) B A U1 U0 X1

  7. AN INCREASE in INCOME v A SUBSIDY on ONE PRODUCT ONLY To illustrate the equal cost nature of the the subsidy v. the income increase, you draw a line parallel to the original budget constraint which passes through the point B (as B must be affordable after the income increase).

  8. AN INCREASE in INCOME v A SUBSIDY on ONE PRODUCT ONLY But which makes the consumer better off ? X2 U2 The increase in income leaves the consumer at C (better off than at B) C B A U1 U0 X1

  9. AN INCREASE in INCOME v A SUBSIDY on ONE PRODUCT ONLY But which makes the consumer better off ? X2 U2 The increase in income leaves the consumer at C (better off than at B) C B A U1 U0 X1

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