East West University

Department of Economics
Semester: Fall 2017
ECO315: Public Finance
Section: 1
Course Instructor: Mir Tanzim Nur Angkur (MTNA)
Senior Lecturer

Q1. Suppose Monir, a university student is fond of reading diverse books of various topics
beside academic text books. He prioritized reading liberation history and travel related books
which give him immense pleasure. Let us suppose the utility function of this student from
reading these books is: U= f(L,T) = (𝑄𝐿 × 𝑄𝑇)

where 𝑄𝐿 = number of liberation history books & 𝑄𝑇= number of travel related books

Now consider the following combination of books:

Option-A: 3 travel related books and 2 liberation history books
Option-B: 2 travel related books and 3 liberation history books
Option-C: 3 travel related books and 3 liberation history books

(i) Graph Monir’s preferences across different options and draw relevant indifference curves and
state the reason which option he would like to have.

Suppose he has Tk.1200 to spend on liberation history books and travel related books in a book
fair. The average price of liberation history book is Tk.200 and the average price of travel related
book is Tk.100.

(ii) Graph the budget constraint for the student.

(Keeping liberation history books on horizontal axis and travel related books on the vertical axis)

(iii) What is the slope of the budget constraint?

(iv) Find the optimal number of books that the student must buy given his budget constraint.

Suppose the government wants to encourage readers to read liberation history books therefore
decides to subsidize on liberation history books by lowering the prices by 50%. Now graph the
budget constraint in this circumstance.

(v)Find the new optimal number of books that the student must buy. And comment on the
effectiveness of this government’s decision to subsidize.
Q2. Consider a single mother named Mary and her utility function is of the following form:

U= 100 x ln(C) + 250 x ln(L) where C= Consumption and L= Leisure

(i) Show that she values leisure more relative to consumption by using MRS.

The market wage rate is Tk.20 per hour.

For the TANF scheme:

Benefit Guarantee = Tk. 10000
Benefit reduction rate = 50%.

Now consider the fact that she works less than 1000 hours.

(b) Write down her budget constraint segment provided that she is in TANF program.

(c) Find the optimal level of leisure, consumption and the value of utility she derives in this case.

Now the TANF scheme changed to:

Benefit Guarantee = Tk. 6000
Benefit reduction rate = 50%.

Now consider the fact that she works less than 600 hours.

(d) Write down her budget constraint segment provided that she is in TANF program.

(e) Find the optimal level of leisure, consumption and the value of utility she derives in this case.

(f) What is the effect on leisure, consumption and utility of this single mother for the change in
TANF scheme?

Q3. Consider an income guarantee program with an income guarantee of Tk.6,000 and a benefit
reduction rate of 50%. A person can work up to 2,000 hours per year at Tk.8 per hour.

(i) Draw the person’s budget constraint with the income guarantee.

Suppose that the income guarantee rises to Tk.9,000 but with a 75% reduction rate.
(ii) Draw the new budget constraint.

(iii) Which of these two income guarantee programs is more likely to discourage work? Explain.

Instruction to students:
 Write your answers neatly.
 You should submit the assignment individually.
 Last date of submission: 19th October , 2017 (Thursday)