“There Is No Economic Case for Having Any Targeted Benefits” to What Extent Is This Statement Supported by Theory and Evidence?

Topics: Consumer theory, Indifference curve, Pareto efficiency Pages: 5 (1991 words) Published: February 25, 2013
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“There is no economic case for having any targeted benefits” To what extent is this statement supported by theory and evidence?

Throughout history, governments have suggested that individuals have invalid preferences over consumption. Whether governments justify this belief through the existence of externalities or through plain paternalism, action is taken to distort consumers’ choice in favour of the government’s projected preferences. One way governments achieve this is by choosing in kind transfers, or targeted benefits, over cash transfers. In doing so, Governments can theoretically insure that the targeted consumers spend a minimum amount on a certain good or service. In this essay, I hope to diagrammatically and intuitively support the theory behind carte blanche principle, before extending the principle to a real life example, more specifically, to the United States Supplemental Nutrition Assistance Program, commonly known as the Food Stamp Program. The carte blance principle implies that targeted benefit recipients would be weakly better off if they were given cash instead of an equivalent amount in targeted benefits.[1] Consumers are ‘weakly’ better off because they would either be better off or indifferent with a cash transfer opposed to a targeted benefit. Which category a consumer falls in depends on whether they are inframarginal or distorted. Inframarginal consumers are indifferent because they already spend at least the value on the targeted good then the targeted benefit allows. For these consumers, a targeted benefit would free up the money that was already being spent on the targeted good to increase expenditure on targeted and non targeted goods. Therefore inframarginal consumers are able to maximise their utility to the same level of utility subject to their budget constraint, regardless of whether the benefit was in kind or a transfer thus avoiding any dead weight loss. However the same cannot be said for distorted consumers, which is where targeted benefits has the most ‘bite’. Distorted consumers are those that would otherwise spend less than the value of the targeted benefit on the targeted good. These are the people that the targeted benefit is designed for, because it is thought they aren’t consuming enough of the targeted good. Figure 1 shows distorted consumers’ strong preferences for the non targeted goods. The diagram shows that before the targeted benefit, the consumer optimises her utility by choosing the bundle of goods in her budget set that is on her highest indifference curve. This occurs at e0, where the indifference curve u0 is tangential to her budget constraint. The in kind transfer in the targeted good horizontally shifts her budget constraint outwards, increasing her opportunity set and allowing her to consume q1 of the targeted good (the minimum amount) and more of the non targeted good. However this is a corner solution because the distorted consumer values the last pound spent on non targeted goods more than the last in kind transfer (with a cash equivalent of a pound) spent on targeted goods. Hence if the distorted consumer was given a cash equivalent transfer, as shown by the dotted budget constraint, then she would spend less on targeted goods (q2) and more on non targeted goods. This different bundle of goods (e2) attained from a cash transfer allows her to reach a higher indifference curve of u2 than if she received a targeted benefit. The difference in the indifference curves u1 and u2 show that targeted benefits are economically inefficient in maximising utility. Firstly, there isn’t allocative efficiency because cash transfers are in higher demand than targeted benefits by distorted consumers....
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