Question

What happens to the utility of a food stamp recipient--coupons entitling certain type of food items--if he/she is compensated with cash instead? Support your answer graphically.

Answer 1

Original budget line: AB

Budget line with food stamps: AFC

Budget line with cash subsidy: DC

Original IC: IC0

Original consumption: Point 0

In case of food stamps, consumption moves from point 0 to 1, which leads to higher food consumption and unchanged consumption of other goods.

In case of cash tranafers, consumption moves from point 0 to point 2, which leads to higher consumption of both food and other goods

This means consumer will be better off in case of cash transfers, as his total consumption and utility is higher in this case.