Question

President Clinton's crime bill from 1994 suggested a federal program that worked much like a price subsidy; the federal government would augment local government expenditures on police with additional funds from the federal treasury. (Assume police services is a normal good).

A. Draw an indifference curve diagram that depicts the changes in consumption of Police Services (x-axis please) and all other goods that occurs when the government first offers a police services subsidy to a state.

B. Congressional Republicans wanted to replace this price subsidy with block grants to the states that would involve just giving the states a set amount of money, which they could allocate as they chose. Suppose a state is receiving $100 million from the federal government under the price subsidy system in part A.. Now suppose the funding is changed so they receive a $100 million block grant. Analyze the impact on spending for "police services" and "all other goods" for this particular state using an indifference curve diagram. In particular, will "police services" increase, decrease, remain unchanged or is it impossible to tell? Why? What would happen to state “utility” under the block grant program versus the police services subsidy.

Answer 1

a)

The above diagram depicts the IC curves of before subsidy and after subsidy to the police.After offering price subsidy to the states the consumption of police services increase as it is a normal good and on offering of subsidies the budget line PL1 shifts to PL2.

On shifting the IC curves also present on the new budget line indicate higher quantity of police services being used by the state ( from Q1 to Q2) and higher utility.

b)

The above diagram indicates a case of cash grant by the government instead of price subsidy. As the state is provided with grant it's income rises leading to shifting in the budget line PL1 to QR. The previous price subsidy offered made the budget line shift to PL2.

Now due to the cash grant the new budget line indicates a higher utility level which is provided by IC3 at b.

Corresponding to b we see that the consumption of police services by the state has decreased to Q3 from Q2.

The possible reason is when the state is provided with a cash grant it can put the money to alternative uses instead of police services. Other goods can be consumed instead of police services (which is presented to be normal good) like infrastructure development, etc.

Also at the new budget line due to cash grant the indifference curve as also risen indicating higher utility to the State.

So in conclusion the state would be at a higher utility if provided with block grant of 100 mn$ instead of a price subsidy of 100 mn dollar if the utility is kept in mind.