GROUP ASSIGNMENT

Course Name: Microeconomics

Course Code: 201
Topic: How tax, subsidies, Group Number-k
and rationing affect
budget line? Illustrate

Prepared For
Sharmeen Mobin Bhuiyan
Associate Professor
Institute of Health Economics
University of Dhaka
Prepared by Student ID
Md. Sumon Ahmed 15
Sobuj Alom 17
Md. Manik Islam 27
Md. Shakil Ahmed 29
Sabir Uddin 37
Nazmul Huda Naeem 41
Md. Rakibul Islam 42
For completing assignment, we have studied our microeconomics book and
collected a lot of information from Google.

Firstly, we will show how tax affects budget line.

For explanation how tax affects budget line we need to know about budget line
and tax properly.

Budget constraint

Budget is a formal statement of estimated income and expanses based on future

plans and objectives.

Budget constraint is the consumer’s affordable consumption bundles are those

that don’t cost any more than income. The budget constraint of the consumer can
be written as: p1x1+p2x2 =m

Now, we will show it graphically.

X2

m
P2
Budget line

X1
0
m
P1

Figure-1: Budget line

In a graph, by using budget constraint we get an affordable line it’s called budget
line. The budget line is the set of bundles that cost exactly m.

Tax

A tax is a compulsory financial charge or some other type of levy imposed upon a
taxpayer (an individual or legal entity) by a governmental organization in order to
fund government spending and various public expenditures.

There are different types of tax in microeconomics.

1. Quantity tax
2. Value tax
3. Lump-sum tax

Quantity tax

The consumer has to pay a certain amount to the government for each unit of
the goods he purchases.

Quantity tax is imposed on good 1 and the amount of a tax is t.

If government imposes the tax on good 1, the price of the good changes and
affects the budget line.

The increases price is (p1+t)

Now, we will show it graphically

X2

m
P2

0 X1
m m
P1+t P1

Figure-2: quantity tax imposing affects budget line

The above graph, we see the budget line for good x 1 in horizontal axis and x2 in
𝑚 𝑚
vertical axis. Price for budget constraints ( , ) when income m. After imposing
𝑝1 𝑝2

quantity tax in good 1, the price of x1 decreases. So, budget line becomes steeper.
𝑚 𝑚
Then we get the budget constraint (x1. + x2. ) =m
𝑝1+𝑡 𝑝2

Value tax

This is a tax on the value the price of a good. A value tax is usually expressed in
percentage terms. Value tax is known as ad valorem tax.

After imposing tax on good 1, the price will be (1+𝜏) p1.

Ad valorem tax makes budget line steeper like quantity tax. We have already
drawn the graph above.

Lump-sum tax

The government takes away some fixed amount of money. Lump-sum tax means
the budget line of a consumer will shift inward because his money income has
been reduced.

Now, We will show it graphically

X2

m
P2

m’
P2

0 X1
m’ m
P1 P1

Figure-3: lump-sum tax imposing affects the budget line

The figure-3 shows when govt imposes lump-sum tax, the budget line shift
inward.

Secondly, we will show how subsidy affects budget line.

Subsidy

Subsidy is an opposite of tax. Subsidies are provided by government to reduce prices

of goods. Subsidy makes the budget line flatter and outward.

There are different types of subsidies in economics.

 Quantity subsidy
 Ad-valorem subsidy
 Lump-sum subsidy

Quantity subsidy

Quantity subsidy means government gives an amount to the consumers that

depends on the amount of goods purchased. Quantity subsidy makes the budget line
flatter. After imposing quantity subsidy on good 1, the budget constraint: (p1-𝜎)
x1+p2x2=m. That means, if the government gives quantity subsidy on good 1, it
affects the budget line and as a result budget line becomes flatter.

X2

m
P2

X1
0 m
m
P1 P1--𝝈

Figure-4: Quantity subsidy imposing affects budget line

We can see the graph, when good 1 becomes cheaper; the budget line becomes
flatter because of subsidy affect.

Ad-valorem subsidy

Ad-valorem subsidy is a subsidy based on the price of the good being subsidized.

Budget constraint without subsidy: p1x1+p2x2=m

If government gives subsidy on good 2, the price of good 2 will reduce and budget
line will be flatter.

After imposing ad-valorem subsidy on good 2, the budget constraint:

p1x1+p2 (1 - 𝜎) x2=m

Ad valorem subsidy makes the budget line flatter like quantity. We have already
drawn the graph above.

Lump-sum subsidy

Lump-sum subsidy means the government gives some fixed amount of money.
Lump-sum subsidy shift budget line outward because of price reduces.
X2

m’
P2

m
P2

0 X2
m m’
P1 P1

Figure-5: Lump-sum subsidy imposing affects budget line

The figure-5 shows when government gives lump-sum subsidy, the price of good
reduces and budget line shift outward.

So, subsidy affects budget line. As a result budget line becomes sometimes flatter,
sometimes shift outward.

Thirdly, we will show how rationing affects budget line.

Rationing

Rationing is the practice of controlling the distribution of a good or service in

order to cope with scarcity. Rationing is a mandate of the government, at the
local government. It can be undertaken in response to adverse weather
condition, or in more extreme cases, during a recession or a war.

The Bangladesh government has announced to bring 50 lakh more poor people
under the governments ration card facilities to provide them with rice at Taka 10
per kilogram to mitigate their sufferings created in the wake of the corona virus
outbreak.

Another example, during World War II the US government rationed certain foods
like butter and meat.

Suppose for example that good 1 was rationed so that no more that x could be
consumed by a given consumer. Then the budget set of the consumer would
look like that in the depicted figure. It would be the old budget set with a piece
lopped off. The lopped off piece consist of all the consumption bundle that are
affordable but have x1>x1
 X2

0 X1
X1

Figure-6: rationing imposed affects budget line

The graph shows that if good 1 is rationed, the section of the budget set
beyond the rationed quantity will be lopped off.