Question

In: Economics

During the energy crisis of the mid-1970s a proposal was made to increase the tax on...

During the energy crisis of the mid-1970s a proposal was made to increase the tax on gasoline by 50¢ per gallon. The government would give poor consumers an amount of cash large enough that they could buy their original bundle (of gasoline and other goods). 1. Show how a typical poor person’s budget line changes as a result of the tax and the subsidy.

2. Use a graph to show how the tax and subsidy could affect this person’s optimal bundle.

3. Is this individual better or worse off or stay on the same bundle as a result of the tax and the subsidy? Explain your answer using your graph and show the possible scenarios.

Solutions

Expert Solution

Ans 1)

how a typical poor person’s budget line changes as a result of the tax and the subsidy.To understand this concept i conclude an example of poor person who name is Jose who represents the budget line via graphical representation we is explained below:

,In a budget constraint, taaqqqqhe quantity of one good is measured on the horizontal axis and the quantity of the other good is measured on the vertical axis. The budget constraint shows the various combinations of the two goods that the consumer can afford. Consider the situation of José, as shown José likes to collect T-shirts and movies.

the number of T-shirts José will buy is on the horizontal axis, while the number of movies he will buy José is on the vertical axis. If José had unlimited income or if goods were free, then he could consume without limit. But José, like all of us, faces a budget constraint. José has a total of $56 to spend. T-shirts cost $14 and movies cost $7.

Plotting the budget constraint is a fairly simple process. Each point on the budget line has to exhaust all $56 of José’s budget. The easiest way to find these points is to plot the intercepts and connect the dots. Each intercept represents a case where José spends all of his budget on either T-shirts or movies.

If José spends all his money on movies, which cost $7, José can buy $56/$7, or 8 of them. This means the y-intercept is the point (0,8). Here, José buys 0 T-shirts and 8 movies.

If José spends all his money on T-shirts, which cost $14, José can buy only 4 of them ($56/$14). This means the x-intercept is the point (4,0). Here, José buys 4 T-shirts and 0 movies.

By connecting these two extremes, you can find every combination that José can afford along his budget line. For example, at point R, José buys 2 T-shirts and 4 movies. This costs him:

T-Shirts @ $14 x 2 = $28

Movies @ $7 x 4 = $28

Total = $24 + $28 = $56

This point indeed exhausts José’s budget.

Ans 2)

The graphical representation of budget line shows how the tax and subsidy could affect this person’s (jose consider as an example of poor person affecting his optimal bundle)

Budget Constraints

Suppose José purchase at some point along the budget line, depending on his preferences. Note that any point within the budget line is feasible. José can spend less than $56, but this is not optimal as he can still buy more goods. Since T-shirts and movies are the only two goods, there is no ability in this model for José to save. This means that not spending his full budget is essentially wasted income. On the other hand, any point beyond the budget line is not feasible. If José only has $56, he cannot spend more than that. Notice that areas in the green zone are not necessarily more optimal than points along the budget line. The optimal point depends on José’s preferences, which we will explore when we discuss José’s indifference curve.

Though we can easily just connect the X and Y intercepts to find the budget line representing all possible combinations that expend José’s entire budget, it is important to discuss what the slope of this line represents. Remember, the slope is the rate of change. In economics, the slope of the graph is often quite important. In this situation, the slope is QY/QX. If we want to represent slope in terms of prices it is equal to Px/PY. This can seem unintuitive at first, as we are used to seeing slope as Y/X., but the reason this is not true for prices is because the y-axis represents quantity, not price. As we saw above, as price doubles, the quantity the consumer could previously purchase is halved.

If José is making $56:

When the price of movies is $7, he can buy 8 of them

When the price of movies is $14, he can buy 4 of them

Since price and quantity have this inverse relationship, we can use either Px/PY or QY/QX to find the slope. Since price is often the information given, it is important to remember that the slope can be calculated either way.

Ans 3)

Yes this individual stay on the same bundle as a result of the tax and the subsidy because of the following conditions which is explained graphically with possible scenarios are as follows:

The meaning of the budget line’s slope or price ratio is the same as the slope of a PPF. (The difference between these two curves is that the PPF shows all the different combinations given time a time/production constraint, whereas a budget line shows different combinations given budget constraint. Otherwise, the two graphs are basically the same). This means the slope of the curve is the relative price of the good on the x-axis in terms of the good on the y-axis. The price ratio of 2 means that José must give up 2 movies for every T-shirt. Likewise, the inverse slope of 1/2 means that José must give up 1/2 a T-shirt per movie.

Condition 1:When Income Changes

Because budget and prices are prone to change, José’s budget line can shift and pivot. For example, if José’s budget drops from $56 to $42, the budget line will shift inward, as he is unable to purchase the same number of goods as before.

To plot the new budget line, find the new intercepts:

Budget: $42

Price of movies: $7

Price of T-shirts: $14

Maximum number of movies (y-intercept): $42/$7 = 6

Maximum number of T-shirts (x-intercept): $42/$14 = 3

As a result of the shift, José’s budget line has shifted inward, leaving less consumption opportunities available.

Condition 2:When Price Changes

In addition to income changes, sometimes the prices of movies and T-shirts rises and falls. Suppose, from our original budget of $56, movies double in price from $7 to $14. Again, to plot the new graph, simply find the new intercepts:

Budget: $56

Price of movies: $14

Price of T-shirts: $14

Maximum number of movies (y-intercept): $56/$14 = 4

Maximum number of T-shirts (x-intercept): $56/$14 = 4

As a result of the pivot, José has fewer consumption opportunities available and the slope of the line changes. This has two effects:

The Size Effect: There are fewer opportunities for consumption (as a result of the price change, the purchasing power of José’s dollar has fallen).

The Slope Effect: The relative price of movies is now higher, while the relative price of T-shirts is now lower.

Condition 3:When Price and Income Change

The last type of change is when both price and income change. Suppose the price of movies increases from $7 to $12 and José’s budget increases to $63. To plot the new budget line, follow the same steps as before:

Budget: $63

Price of movies: $12

Price of T-shirts: $14

Maximum number of movies (y-intercept): $63/$12 = 5.25

Maximum number of T-shirts (x-intercept): $63/$14 = 4.50

These changes have interesting effects. José now has access to some new consumption opportunities, but many others are now unavailable. While the slope effect has clearly made the relative price of T-shirts lower, the size effect is uncertain. These effects are implicit in the income and substitution effects we will explore shortly.

Conclusion

Though we understand the different ways by which consumers can exhaust their income, we have not yet discussed how to determine which bundles of goods different consumers prefer.


Related Solutions

During the 1970s, America faced an energy crisis and stagflation (stagnant economic growth with high inflation)....
During the 1970s, America faced an energy crisis and stagflation (stagnant economic growth with high inflation). Ronald Reagan came to power touting supply-side economic theory (cut taxes on the wealthy so that they would invest more which would, in turn, create jobs). The immediate results of his policies was the worst recession since the Great Depression. By the end of 1983 the economy was recovery and by the end of 1984 the stock market was soaring. How were average Americans...
1. What events or historical forces contributed to the Boston busing crisis of the mid-1970s? Name...
1. What events or historical forces contributed to the Boston busing crisis of the mid-1970s? Name at least three, and briefly explain why you think each one was a contributory cause of the Boston busing crisis 2. Name three specific consequences of the Boston busing crisis.
2. During the 1970s, an unexpected increase in inflation tended to make a currency depreciate. In...
2. During the 1970s, an unexpected increase in inflation tended to make a currency depreciate. In 2020, it is more likely that increased inflation would cause the AUD to appreciate. Identify the main reason for this apparent paradox. 3。I would like you to read the following paper, which is available via the library, and via Module 9 of our course. Exchange Rate Behaviour During the Great Recession, by John T. Harvey. Journal of Economic Issues, Vol 46, Issue 2, 2012....
6. There was a large jump in shrimp prices in the mid-1970s. A newspaper writer wondered...
6. There was a large jump in shrimp prices in the mid-1970s. A newspaper writer wondered why, if people refused to buy shrimp at those outrageous prices, the prices, the pries wouldn’t come down. The President of the National Fisheries Institute replied, “Under basic economics the price should drop as people like you and me reduce our demand for shrimp because we can’t afford it. But the laws of economics don’t stand up in the marketplace where the product is...
What led to the demise of ‘conventional Keynesian wisdom’ in the mid 1970s and why did...
What led to the demise of ‘conventional Keynesian wisdom’ in the mid 1970s and why did the theory of rational expectations make the ‘monetarist experiment’ in the early 1980s more attractive to politicians?
The period post the Second World War to the mid 1970s saw the US and Europe,...
The period post the Second World War to the mid 1970s saw the US and Europe, enjoy their highest GDP growth rates, before or since. What were the major ‘pillars’ responsible for this achievement?
3. Describe the crisis of the 1970s by discussing the Social Structure of Accumulation as described...
3. Describe the crisis of the 1970s by discussing the Social Structure of Accumulation as described by Bowles, Gordon and Weisskopf. Include in your answer the variables in their after tax rate of profit model and the institutions that influence them.
Explain the crises that have affected the world economy; the oil crisis of the 1970s, the...
Explain the crises that have affected the world economy; the oil crisis of the 1970s, the debt crisis of the 1980s, the crisis in the ERM in 1992, and the crisis in East Asia in 1997/98. To what extent does the world’s experience with crises allow them to be better anticipated?
The Watergate crisis in the early 1970s led to the first resignation of a sitting president...
The Watergate crisis in the early 1970s led to the first resignation of a sitting president in American history. What did Richard Nixon do in the Watergate crisis to lead to his resignation?
During the last energy crisis, a government official claimed that the average car owner refilled the...
During the last energy crisis, a government official claimed that the average car owner refilled the tank when there was more than 3 gallons left. To check the claim, 10 cars were surveyed as they entered a gas station. The amount of gas was measured and recorded as shown below             3          5         3         2         3         3         7         6         4         4 Assume that the amount of gas remaining in tanks is normally distributed with a standard deviation of 1 gallon....
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT