Answer to Question #195034 in Microeconomics for Raathika

Question

(a) The local authority of Islington has £2 million to spend either on park maintenance or private goods. Each unit of park maintenance costs £10,000. (i) What is the maximum units of private goods that Islington can afford? What is the maximum units of the public good Islington can afford? At what units of public and private goods does Islington’s indifference curve over these two goods become tangent to its budget constraint? (ii) Now suppose that the central government decides to subsidize Islington’s purchase of park maintenance by providing the local authority with 1 unit of maintenance for every 2 units it purchases on its own. Will Islington purchase more or fewer units of park maintenance? Will Islington purchase more or fewer units of the private good? Explain. (Assume both private good and park maintenance to be normal goods.) (iii) What is the outcome if the central government instead provides a block grant such that the cost to the government is the same?

Answer 1

(a)

(i) The maximum units of public goods that Islington can afford is 2,000,000/10,000 = 200 units.

The maximum units of the private goods Islington can afford can't be determined without knowing the price. At point between 0 and 200 units of public goods Islington’s indifference curve over these two goods becomes tangent to its budget constraint.

(ii) Islington will purchase more units of park maintenance and the same amount of the private good.

(iii) if the central government instead provides a block grant such that the cost to the government is the same, then the consumption will not change.