MicroEconomics theory and application 12th by browning an zupan chapter 05

Prepared by Dr. Della Lee Sue, Marist College

MICROECONOMICS: Theory & Applications
Chapter 5: Using Consumer Choice Theory
By Edgar K. Browning & Mark A. Zupan
John Wiley & Sons, Inc.
13th Edition, Copyright 2015

Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.


Learning Objectives





Determine how an excise subsidy affects consumer welfare
and why it results in a deadweight loss.
Examine how the public provision of a certain quantity of a
good such as education may lead to less consumption of the
good.
Analyze how a voucher program would affect the quantity
of educational services chosen by parents for their children.
(continued)

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Learning Objectives






(continued)

Explore the impact of per-bag charges versus a fixed annual
fee on the amount of trash generated by a community,
recycling, and household welfare.
Develop an intertemporal model that illuminates the
consumer’s choice to save or borrow and shows how
changes in endowment and the interest rate affect that
choice.
Understand how the theory of consumer choice can explain
what types of financial assets an individual intent on saving
for the future should purchase, or invest in.

Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.

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Determine how an excise subsidy affects consumer welfare and why it
results in a deadweight loss.

5.1 EXCISE SUBSIDIES, HEALTH
CARE, AND CONSUMER WELFARE

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Excise Subsidies, Health Care, and
Consumer Welfare
Excise subsidy – a form of subsidy in which the government
pays part of the per-unit price of a good and allows
consumers to purchase as many units as desired at the
subsidized price


Example: tax credit for a expenditures on a specific good or service



Lowers the price to the consumer or taxpayer

Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.

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Figure 5.1 - Excise versus Lump-Sum
Subsidy

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The Relative Effectiveness of a LumpSum Transfer


Lump-sum transfer – a form of subsidy in which the
government gives the consumer a cash grant to be spent in
any way the recipient wants.


Cash transfer: has an income effect



Excise subsidy: has both an income effect and a substitution effect



Consequently, consumers prefer a cash grant but they do not necessarily purchase
more of an otherwise subsidized good

Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.

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Using the Consumer Surplus Approach


Implication – The consumer could be better off with an
alternative subsidy of the same cost to the government



Deadweight loss – a measure of the aggregate loss in wellbeing resulting from output not being at the efficient level



It does NOT mean that the consumer is worse off under the
excise subsidy than with no subsidy at all.

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Figure 5.2 – Excise Subsidy Using
Consumer Surplus

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Subsidizing Consumption


The government has two ways to subsidize consumption:






Reduce the price
Provide a particular quantity of the good or service at a price below the market price

Examples:






Health insurance
Education
Garbage disposal
The Consumer’s Choice to Save or Borrow
Investor Choice

Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.

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Examine how the public provision of a certain quantity of a good such as
education may lead to less consumption of the good.

5.2 SUBSIDIZING HEALTH
INSURANCE: OBAMACARE

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Subsidizing Health Insurance: Obamacare




Patient Protection and Affordable Care Act, enacted March
23, 2011
Major goal: reduce the number of people without health
insurance
Program components:


subsidization of individual health insurance purchases (discussed here)



Expansion of existing government welfare programs

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The Basics of Obamacare






Health insurance policy offering specific coverage
(determined by the government) to those eligible for the
subsidy
Regressive (subsidy decreases as income increases)
Following slides: application of consumer choice theory to
examine the effects of subsidization

Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.

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Figure 5.3 – Health Insurance Subsidy’s
Effect on the Budget Line

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Bringing in Preferences




Two alternatives


Subsidy – uninsured recipient is left equally well off with subsidy



Unrestricted cash transfer – recipient is better off with monetarily equivalent cash
transfer



Outcome: deadweight loss (inefficiency)

Considerations in ObamaCare legislation


Mandate to require health insurance policy



Pay a fine instead of participation in program

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Figure 5.4 – The Optimal Consumption
Choice and the Resultant Deadweight Loss

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Figure 5.5 - A Case Where Mandated
Insurance Harms Subsidy Recipients

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Analyze how a voucher program would affect the quantity of educational
services chosen by parents for their children.

5.3 PUBLIC SCHOOLS AND THE
VOUCHER PROPOSAL

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Public Schools and the Voucher
Proposal




Alternative form of subsidy: government offers a specific
quantity of a good at a cost that is below market price.
Example: public school voucher
Voucher program: a subsidy in which parents receive
vouchers that can be used to purchase education at any
school of their choice

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Using Consumer Choice Theory to
Analyze Voucher Proposals




Expected outcomes


Some families purchase a larger quantity of educational services.



Some families purchase a type of education that they view as superior.

Unintended consequences


Competition between public and private schools could lead to improved quality of
education in both schools.



The education system could become more segmented.

Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.

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Figure 5.6 – Fixed-Quantity Subsidy:
Education

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Explore the impact of per-bag charges versus a fixed annual fee on the
amount of trash generated by a community, recycling, and household
welfare.

5.4 PAYING FOR GARBAGE

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Paying for Garbage


Original trash collection plan: residents pay a fixed annual
price for pick up




Those with less garbage subsidized those with more garbage

New plan: residents purchase garbage collection bags at a
price that exceeds their cost, which generates a net revenue
that is used to finance garbage collection services


Each household pays cost of own trash disposal.



Everyone has an incentive to reduce amount of trash generated.

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Figure 5.7 - Consumer Choice: Garbage

Disposal

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Does Everyone Benefit?
Price-per-bag system:


Each household has an incentive to reduce the amount of garbage generated so
everyone gains.



Households with less than the average amount of trash gain .



BUT since the subsidy to the heavy users is removed, those who generate more than
the average amount of trash lose.

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