Page 477 - The Principle of Economics

between food and nonfood consumption however he pleases. By contrast, if the government gives Paul an in-kind transfer of food, then his new budget constraint is more complicated. The budget constraint has again shifted out. But now the budget constraint has a kink at $1,000 of food, for Paul must consume at least that amount in food. That is, even if Paul spends all his money on nonfood consump- tion, he still consumes $1,000 in food.
The ultimate comparison between the cash transfer and in-kind transfer de- pends on Paul’s preferences. In panel (a), Paul would choose to spend at least $1,000 on food even if he receives a cash transfer. Therefore, the constraint im- posed by the in-kind transfer is not binding. In this case, his consumption moves from point A to point B regardless of the type of transfer. That is, Paul’s choice be- tween food and nonfood consumption is the same under the two policies.
In panel (b), however, the story is very different. In this case, Paul would pre- fer to spend less than $1,000 on food and spend more on nonfood consumption. The cash transfer allows him discretion to spend the money as he pleases, and he consumes at point B. By contrast, the in-kind transfer imposes the binding con- straint that he consume at least $1,000 of food. His optimal allocation is at the kink, point C. Compared to the cash transfer, the in-kind transfer induces Paul to con- sume more food and less of other goods. The in-kind transfer also forces Paul to end up on a lower (and thus less preferred) indifference curve. Paul is worse off than if he had the cash transfer.
Thus, the theory of consumer choice teaches a simple lesson about cash versus in-kind transfers. If an in-kind transfer of a good forces the recipient to consume more of the good than he would on his own, then the recipient prefers the cash transfer. If the in-kind transfer does not force the recipient to consume more of the good than he would on his own, then the cash and in-kind transfer have exactly the same effect on the consumption and welfare of the recipient.
QUICK QUIZ: Explain how an increase in the wage can potentially decrease the amount that a person wants to work.
CONCLUSION: DO PEOPLE REALLY THINK THIS WAY?
The theory of consumer choice describes how people make decisions. As we have seen, it has broad applicability. It can explain how a person chooses between Pepsi and pizza, work and leisure, consumption and saving, and on and on.
At this point, however, you might be tempted to treat the theory of consumer choice with some skepticism. After all, you are a consumer. You decide what to buy every time you walk into a store. And you know that you do not decide by writing down budget constraints and indifference curves. Doesn’t this knowledge about your own decisionmaking provide evidence against the theory?
The answer is no. The theory of consumer choice does not try to present a lit- eral account of how people make decisions. It is a model. And, as we first dis- cussed in Chapter 2, models are not intended to be completely realistic.
The best way to view the theory of consumer choice is as a metaphor for how consumers make decisions. No consumer (except an occasional economist) goes
CHAPTER 21 THE THEORY OF CONSUMER CHOICE 487