You initially spend all of your income to purchase 5 units of x1 at a price...

You initially spend all of your income to purchase 5 units of x1 at a price of p1 = 2, and you purchase 5 units of x2 at a price of p2 = 4.

(a) The price of x1 rises to p 0 1 = 3. What is the per-unit subsidy on x1 that is required for you to still be able to a§ord to purchase 5 units of x1 and 5 units of x2?

(b) Now say that instead of a quantity subsidy, the government wants to o§er you a lump-sum income transfer. How large must this lump-sum income transfer be to enable you to a§ord 5 units of x1 at a price of p 0 1 = 3 and 5 units of x2 at a price of p2 = 4?

Expert Solution

The budget constraint of the consumer will look like:

1) If the government decides to grant quantity subsidy , then value of subsidy at which individual can afford to consume a bundle of (5,5) can be determined as:

where

s is the rat of subsidy

2) If the government decides to grant lumpsum subsidy , then value of subsidy at which individual can afford to consume a bundle of (5,5) can be determined as:

Rahul Sunny answered 2 years ago

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