Question 1

A typical low-income family has $600 monthly income. They allocate their income between food and other goods. Assume that the price of one unit of other goods is $1 and the price of one unit of food is $6. Each household has usual shaped strictly convex preferences between food and other goods.

The government is planning to provide food support to households with low-income. You have been asked to analyze the following two alternative plans designed for this purpose.

Plan 1. Each family will receive a voucher that can be used to purchase 100 units of food for free. The voucher can only be used to purchase food.

Plan 2. The government will provide a subsidy to low-income families, so that they would only pay $2 per unit of food.

a) Draw the budget constraint for a typical household before the introduction of any government support plan while keeping food on the horizontal axis.

b) Reproduce your diagram from (a) and show how a household's budget constraint changes under Plan 1. Briefly explain your work.

c) Reproduce your diagram from (a) and show how a household's budget constraint changes under Plan 2. Briefly explain your work.