Answer to Question #91812 in Microeconomics for moses nhlane

Question

19) The government is considering two ways to help the needy: giving them cash or giving them free meals at soup kitchens.
a. Give an argument, based on the standard theory of the rational consumer, for giving cash.
b. Give an argument, based on asymmetric information, for why the soup kitchen may be better than the cash handout.
c. Give an argument, based on behavioral economics, for why the soup kitchen may be better than the cash handout.
d. The own price elasticity of apples is –0.8 and the cross elasticity of apples with respect to the price of oranges is 0.5. Suppose that the price of apples rises by 10 percent and the price of oranges falls by 4 percent. What will happen to apple demand?

Answer 1

a. Based on the standard theory of the rational consumer, giving cash is better, because such consumers will spend them as rationally as possible to satisfy their needs.

b. Based on asymmetric information, the soup kitchen may be better than the cash handout, because it is difficult to determine, who needs money more and how much.

c. Based on behavioral economics, the soup kitchen may be better than the cash handout, because some needy people may spend the cash irrationally, for example, on alcohol or drugs.

d. First the quantity of apple demanded will decrease by 0.8×10 = 8 percent, then it will decrease by 0.5×4 = 2 percent, so the total decrease is 10 percent.