II. Consumer demand
    B. Extensions and applications of consumer theory
    4. Policy applications

Ex.2: Oxy education:     Per student amounts in year 2010:     (1) Total expenses: 48,625     (2) Tuition and fees: 38,935     (3) Subsidy: 9,690     BLa: Without subsidy     BLb: With subsidy
Note: The Qx with the subsidy might be so high that you have to extend the BL excluding the subsidy below the horizontal axis to illustrate the subsidy cost to the government.

    In general, the policy impact of taxes and subsidies on good X
    = the vertical distance between the old and new BLs measured at the new Qx.

    Policy application 1: Comparing price and income subsidies
    Policy option 1: subsidize food prices

Consider a low-income family:     Consumes food and other goods.     Allow plenty of room to work to the left of the diagram.     a = no subsidy    I  Pf Qf  Ig a 400 10 20 200    Now suppose the government offers food stamps which lower the family's price of food to $5. ? What happens to the BL y-intercept? ? What happens to the BL slope?

    b = $5 per-unit food price subsidy
       I  Pf Qf  Ig
    b 400  5 35 225
   (1) Government cost of the food price subsidy = $5 x 35 = $175

    Policy option 2: a utility-equivalent income subsidy
    How much would the government have to spend on a utility-equivalent income subsidy compared to the price subsidy? It's smaller

    The government can just give extra income instead.
    ? In that case, how would you show the budget line the family would need to reach Ub at market prices?

    b' = utility-equivalent income subsidy
       I  Pf Qf  Ig
   b' 540 10 24 300

    (2) Government cost for a utility-equivalent income subsidy
    = the vertical distance between Blb' and BLa.

    Utility-equivalent income subsidies are cheaper than price subsidies.

See Worksheet

    But notice also that the family consumes less food than with the utility-equivalent price subsidy. That's due to the substitution effect: since food is more expensive along BLb' than Blb, the family consumes less food.
    Note1: The cost of government programs of product-specific subsidies such as food stamps tends to overstate the value of the subsidies to the beneficiaries. This makes it difficult to determine the true impact of government programs on income redistribution.
    Note2: The 'right' choice of policy depends on the goal. To specifically boost food consumption to quantity Fb, use a food price subsidy, but if the goal is just to raise the family's welfare to Ub, then use an income subsidy.
    Note3: Self-test: try taxes instead of subsidies and contrast the effects of a product tax versus an income tax

Policy application 2: Taxes and rebates (see example (Java)) Mankiw's blog: Thursday, February 05, 2009 My Preferred Fiscal Stimulus     Regular readers of this blog have a pretty good sense of my policy preferences. But for those occasional readers who might be stopping by, let me reiterate what I would do right now if I were the fiscal king.     I would institute an immediate and permanent reduction in the payroll tax, financed by a gradual, permanent, and substantial increase in the gasoline tax. I would make the two tax changes equal in present value, so while the package results in a short-run budget deficit, there is no long-term budget impact. Call it the create-jobs, save-the-environment, reduce-traffic-congestion, budget-neutral tax shift.     How would that work?     See worksheet Characteristics of final new optimum:     (1) Higher MRS (=new Pgas)     (2) Original BL (since all of gas tax is rebated)
Consumption point Money income Pgas Qgas TEgas Ig (1) Before tax/rebate a $450 $3.00 40 $120 $330 (2) After $1.50 tax b $450 $4.50 30 $135 $315 (3) After tax+rebate c $501 $4.50 34 $153 $348

    Final comments regarding consumer theory:
    For more practice: Worksheet of applications
    In many cases, the usual old demand curve does well enough, but it has limitations, and the set of tools used for consumer theory allows us to do a better job. They...
    Resolve possible contradictions (Giffen goods, cross-price elasticities)
    Increase precision (CV and true change in CS)
    Extend the range of questions we can tackle (price vs. income subsidies)
    Highlight consumer choice and the trade-offs between products--and that's what econ is about, choice and trade-offs