The government often helps those affected by a natural disaster by subsidizing reconstruction. Households who qualify for the program pay a price P-S per “unit of reconstruction” (where P is the regular price). An economist who advises the government argues that this program should be reformed. Specifically, the economist argues that the government should provide free reconstruction up to a certain amount. Any amount in excess is charged at the regular price, P. The economist argues that if the government spends the same amount of money in this alternative program, then the following would be the case: The households would be better off. Less reconstruction will be undertaken (which may be desirable if the people live in a natural disaster-prone area). Demonstrate by means of a graph that the economist is right, assuming that preferences over “reconstruction” and “all other goods” are convex and monotonic. (Big Hint: First graph the budget line without any program putting other goods on the vertical axis and reconstruction on the horizontal axis. Then graph the budget constraint with the current program. Graph an optimal consumption point, given normal preferences. Then determine the budget line for the alternative program (remember it costs the same amount of money as the original program)).
The government often helps those affected by a natural disaster by subsidizing reconstruction. Households who qualify for the program pay a price P-S per “unit of reconstruction” (where P is the regular price). An economist who advises the government argues that this program should be reformed. Specifically, the economist argues that the government should provide free reconstruction up to a certain amount. Any amount in excess is charged at the regular price, P. The economist argues that if the government spends the same amount of money in this alternative program, then the following would be the case:
- The households would be better off.
- Less reconstruction will be undertaken (which may be desirable if the people live in a natural disaster-prone area).
Demonstrate by means of a graph that the economist is right, assuming that preferences over “reconstruction” and “all other goods” are convex and monotonic. (Big Hint: First graph the budget line without any program putting other goods on the vertical axis and reconstruction on the horizontal axis. Then graph the budget constraint with the current program. Graph an optimal consumption point, given normal preferences. Then determine the budget line for the alternative program (remember it costs the same amount of money as the original program)).
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