Concerned about the health of low-income families, government officials are considering two alternative plans to help provide access to health care.

Health Insurance Subsidy (HIS): This plan would provide families a 25% tax credit for each dollar spent on health insurance. In effect, a dollar’s worth of insurance would now cost families only 75 cents.

Insurance Vouchers (IV): This plan would give each family a $200 voucher that could be applied to the cost of health insurance. The vouchers have no cash value, so they cannot be used for any expenditure other than health insurance.

You have been asked to evaluate the effect of this plan on a typical low-income family. Government data shows that such a family has a monthly income of $2,000 and that these families spend $400 per month on health insurance. This information means the family’s utility is maximized at $400 per month spending on health insurance.

a.) Draw a budget constraint and indifference curve for the typical family before either policy is chosen. The y-axis should be money to spend on other consumption, and the value is money to spend on health insurance. Be sure to label the endpoints of the budget constraint, as well as spending on insurance and other consumption chosen by this family.

b.) Assuming preferences don’t change, fill in the table below that shows how much the family would pay for $400 worth of insurance without either policy, with the subsidy policy, and with the insurance voucher policy. Also calculate how much the government pays the family in each case, and the total cost of the insurance. (Hint: Calculate how much of their own income families must spend to get $400 worth of insurance under each policy, then how much the government gives that family).

	family	government	total
original
subsidy HIS
Voucher IV

c.) Based on your table in part b.), assuming preferences don’t change, under what plan is the family better off if they want $400 worth of insurance?

d.) Using the concepts of utility and preferences, explain why this family is better off with the policy you chose in part c.). Also, explain how this could change if the family preferred an insurance plan with higher coverage (i.e. higher cost) or lower coverage (i.e. lower cost). You may use a utility graph to illustrate and support your answer, but you do not have to.