1). Subsidy or Cash?

Years ago the Food and Drug Administration (FDA) gave approval to a new, powerful, anti-AIDS drug called ritonavir. The approval process took only 72 days, and is the quickest approval ever given to an AIDS drug. In response, President Clinton pledged to increase government funding by $52 million for a subsidy program created by the Ryan White Act. The additional funds would be used to help cover the costs of AIDS drug treatment that many AIDS patients face by reimbursing some of the treatment and drug costs incurred; in essence, the Ryan White Act@ program provides AIDS patients with a price subsidy. Assume no corner solutions throughout this problem.

a). What is a price subsidy? How would it affect the price that ritonavir users face? Show the effect of the price subsidy on a representative AIDS patient=s demand for ritonavir by showing the pre and post subsidy consumption bundles. Assume ritonavir is a normal good. Hint: Put ritonavir on the horizontal axis, and AOG on the vertical. Also, assume the price of AOG is $1.

b). Decompose this change into substitution and income effects.

c). Redraw your picture to part a) without the substitution and income effects. Show the size of the subsidy the Federal government must pay to this representative AIDS patient.

d). Redraw your graph to part c). A Republican legislator suggests AIDS patients could be made better off by giving cash in the value of the price subsidy. Is this possible? Show graphically and explain.

e). Is it possible to pay an amount less than the subsidy which will deliver the same amount of utility to the patient, yet reduce the cost to the government? What is the economic term for this concept? Does this strike you as a good idea? Why might the Federal government prefer a price subsidy to a cash grant? Show graphically and explain.

-------------------------------------------------------------------------------------------------