1. Per Unit subsidy VS Lump-sum subsidy Suppose the government wants to introduc
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Question
1. Per Unit subsidy VS Lump-sum subsidy Suppose the government wants to introduce some subsidy on good x. It has two op- tions: Per Unit subsidy or Lump-sum subsidy. Suppose consumers take all the subsidy benefit, so we don't need to worry about the subsidy division between the consumers and producers. (a) Suppose the government spends the same amount of money in either subsidy, which kind of subsidy would the consumers prefer? Why? Solution: The consumers would prefer the lump-sum subsidy, because they could obtain a higher utility. (b) Suppose consumers are indifferent between the two kinds of subsidies, which means under either subsidy, the consumers would obtain the same utility level. Which kind of subsidy would the government prefer? Why? Solution: The government would prefer the lump-sum subsidy, because its expenditure is lower.Explanation / Answer
Ans A)
Lumpsum subsidy would obviously provides higher utility than per unit subsidy because later type drives risk of government decision to change in near future regarding subsidy policy which makes consumer to discount future payoff with unequal discount rates specific to each consumer risk profile.
Hence to avoid government policy risk and to earn higher utility lump sum subsidy to be chosen
Ans B)
Lump sum subsidy in such case provides government with one time payment rather future timely payments that is due on their part which obviously incurs cost each time they arrange for payout in future
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