Question

In: Economics

Jane’s current income is $200, the price of food is $4 and the price of all...

Jane’s current income is $200, the price of food is $4 and the price of all other goods is $1. The government gives Jane $100 in food stamps. Draw her budget line. Draw a set of indifference curves that show that Jane would not care whether she receives $100 in cash or $100 in food stamps. Now a black market developes where Jane can trade $1 of food stamps for $.50 in cash. Draw Jane’s new budget line. Will she participate in the black market? Explain your answer.

Solutions

Expert Solution

Let us first derive the Budget line in this case:-

Here, Current Income =$200

Price of food = $4

Price of other goods = $1

We know that the equation of Budget Line is:-

=px.x+ py.Y

Here, px= Price of food, and py = Price of other goods

Putting these values in the above equation we get:-

200 = 4x+y

Thus, the intercept x of the Budget line =/px = 200/4 = 50 ( Consumer will be able to buy 50 units of x)

And, Intercept y of the Budget line = /py = 200/1 = 200 ( Consumer will be able to buy 200 units of y )

Therefore, (50,0 ) and (0,200) are the two combinations that lie on this budget line.

So, the budget line can be drawn in the following manner:-

The slope of this budget line is -px/py =-4/1=-4

Now, before drawing the indifference curves, let us explain in brief what an indifference curve is:-

An Indifference curve is a curve on a graph (the axis of which represent quantities of two commodities) linking those combinations of quantities which the consumer regards as of equal value.

Now, the indifference curves when Jane is indifferent between receiving $100 in cash or $100 in food can be drawn in the following manner:-

If in case a black market develops where Jane trades $1 of food stamps for $50 in cash, the new budget line can be drawn in the following manner:-

Price of Food Stamps now = $1

And, Cash =$50

Price of other goods = $1

Again, the equation of Budget Line is given as :

= px.x + py.y

By putting the values again in the above equation we get:-

x+y = 50

So, the new budget line comes out as:-

No, Jane will not participate in the black market. Before answering this well let us discuss what a black market is. A Black market is also called an underground economy or shadow economy. It is a clandestine market or transaction that has some aspect of illegality or is characterized by some form of noncompliant behaviour with an institutional set of rules. If the rule defines the set of goods and services whose production and distribution is prohibited by law, non -compliance with the rules constitutes the black market trade since the transaction itself is illegal. So, Jane would not trade in the black market because parties who engage in the production or distribution of prohibited goods and services become a member of an illegal economy and Jane won't do that at all.


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