Question

SA 1. Bob supports his family with monthly income of $500. Currently, he spends $200 on food and the remaining $300 on composite goods. Under the new income assistance program to be implemented next year, Bob will become eligible to receive food vouchers. Those vouchers provide Bob with $300 worth of free food every month. However, they cannot be sold or exchanged for other goods. True or False: Assuming that food is an inferior good for Bob, he will be better off if his income increases by the same amount as the food vouchers. With the use of an appropriate diagram explain your answers.SA 2. Suppose that a firm uses labour and capital in production. The wage rate is $10 per unit of labour and the rental cost of capital is $10 per unit. The firm is currently producing 100 units of output by using the cost-minimizing input combination of 50 units of labour and 50 units of capital.On an isoquant and iso-cost diagram, show than an increase in output from 100 units to 150 units will result in higher short-run total costs, average costs and marginal costs than in the long-run counterparts.

Answer 1

The given statement is true. Bob will be better off if his income is increased by the same amount as the food vouchers.

Please refer to the attached image for the diagram and the explanation given below.

The effect of the food subsidy: If the government gives the food vouchers to the consumer worth $300, the budget line of the consumer will rotate from AB to AB'. Here, the new equilibrium of the consumer is given by e2 on IC2 where he buys more food x2 using his subsidy. However, this assistance imposes a certain pattern of consumption on the consumer. He is bound to spend this extra subsidy on food only and cannot buy more of the other goods.

Effect of extra income: If extra income is given to the consumer, his budget line shifts outward. Now he can choose a point according to his preferences whereby he can buy more of both the goods. He chooses point e3 whereby he can buy Y3 amount of composite good and X3 amount of food. Here, both the commodities are more than his original bundle X1.

Thus, with extra income, the consumer is better off as compared to the food subsidy.

(Answered only one question in detail as the other question is not a sub-part but a question from entirely different topic).