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Module 2
THEORETICAL TOOLS & APPLICATION
Lectures (3 - 7)
Topics
2.1 Tools of Public Economics
2.2 Constrained Utility Maximization
2.3 Marginal Rates of Substitution
2.4 Constrained Utility Maximization:
Budget Constraints
2.5 Substitution Effects and Income Effects
2.6 Putting the Tools to Work the Effect of Temporary
Assistance Programs on the Budget Constraint
2.7 Budget Constraint
2.8 The Effect of Temporary Assistance Programs on the
Budget Constraint
2.9 The Effect of Various Policy Changes
2.10 What Happens to Labor Supply in Response to Such a
Policy Change?
2.11 A Different Preference Function
2.12 Summary of Labor Supply Effects
2.13 Recap of Relevant Concepts
2.13.1 Social Welfare
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Perfectly Inelastic
2.14.2
Perfectly Elastic
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NPTEL-Economics-Public Economics
Module 2
Lecture 3
Topics
2.1 TOOLS OF PUBLIC ECONOMICS
Suppose that you are a member of the economic advisory board of the PM and the PM
must decide on the amount of cash transfer that is to be made to the NREGS program.
The chief economic advisor believes that by providing cash to very low income families,
it only encourages them to stay at home rather than go to work. To provide incentives to
these people the government must cut back on the cash benefits. The PM disagrees; he
thinks that poor families who are at home in villages are incapable of finding a job that
pays them high enough to encourage them to work. So if the state cuts the cash benefits it
will only penalize these poor households. You being a researcher are being asked to
inform this debate by assessing the degree to which cutting cash benefits to low income
families will encourage them to work by evaluating the cut.
Such an evaluation would require you to use both theoretical and empirical tools
of economics.
Theoretical tools are a set of tools used to understand economic decision making.
They are primarily graphical and mathematical.
Empirical tools allow you to examine the theory with data.
First we would discuss a few theoretical tools derived from microeconomics that
are most commonly used in public policy analysis. Theoretical Tools: Recap of
utility maximization.
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, , the
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NPTEL-Economics-Public Economics
Figure 3.3
The individual is willing to give up fewer C to get more M when she has more M
than less.
Figure 3.4
NPTEL-Economics-Public Economics
Where,
Y = Income level
PM = Price of movie
PC = Price of CD
Thus, the total amount spent must equal income, assuming no saving or borrowing.
The slope of the budget constraint is:
Optimization Problem :
What is the highest IC that an individual can reach given a budget constraint?
The individual chooses the bundle of goods that gives the highest utility, subject
to the budget constraint.
At the optimum: slope of the indifference curve equals the slope of the budget
constraint.
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Figure 3.5
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Figure 3.7
In Fig 3.7 as
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