Welfare Department Assisting Low-Income Households Essay

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Alternative policies of the welfare department to assist low-income families

A typical low-income household spends its income on two goods x and z and its preferences between these two goods can be represented by usually shaped convex indifference curves.

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Graphical Representation of the above Information.
Figure 1: Graphical Representation of the above Information.

It is noted that the welfare department is considering two alternative policies to meet its target:

Alternative 1

Providing the low-income household with a voucher which can be exchanged for a fixed amount of good x in any supermarket in the country.

Alternative 2

Providing the low-income household with an income supplement sufficient to buy the same amount of good x as stipulated by the voucher from a supermarket. This is assuming that all supermarkets have the same price per unit for good x.

Under what kind of household preferences over the two goods will the two policies always have the same impacts on the household in terms of its utility level and consumption levels of the two goods?

It is under the preference where the consumer is provided with a voucher that can be exchanged for a fixed amount of good X in any supermarket. This is explained in detail below:

Perfect Compliments Preferences

According to Sullivan & Sheffrin (2003), these are goods that are consumed together. This being the case, it is noted that an increase in demand for one of the goods will ultimately lead to an increase in demand for its complement good. In our case, if good X is a compliment to good Z, an increase in supplement income or a voucher for good X will force the household to increase the amount of consumption of good Z. The graph below explains this clearly:

Perfect Compliments Preferences.
Figure 2: Perfect Compliments Preferences.

Indifference curve I shows the aggregate effects of an increase in good X and its effect on good Z. This gives rise to indifference curve II (Gilboa 2009).

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Under what kinds of household preferences over the two goods can the two policies have potentially different impacts on the household in terms of its utility level and consumption levels of the two goods?

It is under the perfect substitute’s preference. This is explained below:

Perfect Substitutes Preference

According to Mankiw (2008) and Carbaugh (2006), these are goods characterized by a scenario where an increase in demand for one good leads to a decrease in demand for the other good. This as a result brings about what Gilboa (2009) refers to as a substitution effect. In our case, a voucher for good X or income supplement for good X will lead to a reduction in demand for good Z. This will in effect reduce the amount of goods consumed by the household in question (Mas-colell, Whinston & Green 2010). This is clearly illustrated in the diagram below:

Graphical Representation of the Perfect Substitute’s Preference.
Figure 3: Graphical Representation of the Perfect Substitute’s Preference.

The curve below shows a decrease in demand for good Z in favor of good X. If a voucher is offered to the low-income households, the unit is going to purchase less of good X and increase the purchases of good X (Perloff 2012). This will in effect lead to the formation of a new budget line A. Regardless of this, the household will remain on the same indifference curve (Mankiw 2008).

Good x and Good z.
Figure 4: Good x and Good z.

According to Sullivan & Sheffrin (2003), if an income supplement is offered instead, the budget line is going to tilt to the right. This will in effect create a new indifference curve.

Will there be a substitution effect associated with either of the above policies?

The substitution effect (herein referred to as SE) comes about when the household remains on the same indifference curve. It happens when the department provides the low-income household with a voucher for good X. This will lead to an increase in the amount of good x that the household consumes and a reduction in the amount of good z consumed. According to Rubin & Capra (2011), this will also change the slope of the budget line and as such, a new budget line will emerge. The low-income household will maintain the same indifference curve because it will substitute good z for good x (Carbaugh 2006).

Substitution Effect.
Figure 5: Substitution Effect.

Adapted from: Carbaugh 2006

Suppose that the welfare department in your country was interested in both improving the utility of the household and increasing its consumption of good x. Will the above policies always succeed in meeting these 2 goals?

According to Sullivan & Sheffrin (2003), a combination of both the voucher and income supplement is sufficient but not enough to improve the utility and consumption of good x. When all other factors are held constant, these two policies are likely to succeed. This is given that there will be a notable increase in demand for good x and a corresponding decrease in demand for good z.

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Other policies that can be used to achieve these objectives include the following:

  • A decrease in the prices of good X,
  • Aggressive marketing campaigns for good X,
  • A change in the price of the goods related to good X, and
  • a change in consumer preference and taste in favor of good X (Mankiw 2008).

A decrease in the prices of good x will make it cheaper while making good z expensive. To obey the law of demand, low prices will attract more households (Mankiw 2008). This will make their preferences shift from good z to good x. At the same time, a vigorous advertisement for good x will create a desire for households to consume more of it. More households will end up purchasing more of good x. This will therefore achieve the goal of increasing the consumption of good x.

A change in the price of goods related to good x will have notable effects on the preference for good x. An increase in prices of goods that are substitutes to good x will mean that more households will opt to consume more of it while reducing the consumption of the substitute goods. Also, a decrease in the price of complementary goods will encourage households to buy more good x, therefore increasing its utility and consumption levels. Also, change in consumer preferences and taste in favor of good x will mean that its demand will rise. This is an indication of the fact that households are adequately utilizing and consuming good x (Carbaugh 2006).

References

Carbaugh, R 2006, Contemporary economics: an applications approach, Cengage Learning, New York.

Gilboa, I 2009, Theory of decision under uncertainty, Cambridge University Press, Cambridge.

Mankiw, G 2008, Principle of economics, Cengage Learning, New York.

Mas-Colell, A Whinston, M & Green, J 2010. Microeconomic theory, Oxford University Press, New York.

Perloff, JM 2012, Microeconomics: global edition, Pearson Education, London.

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Rubin, H & Capra, C 2011, The evolutionary psychology of economics, Oxford University Press, Oxford.

Sullivan, A & Sheffrin, M 2003, Economics: Principles in action, Pearson Prentice Hall, Upper Saddle River, New Jersey.

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IvyPanda. 2021. "Welfare Department Assisting Low-Income Households." January 18, 2021. https://ivypanda.com/essays/welfare-department-assisting-low-income-households/.

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