Economics Question:

A government is concerned about the heating habits of the elderly when there is an increase in fuel prices. Its department of health had warned that people underestimate the amount of heating they need during a cold winter to remain in long term good health. To ensure that the heating habits of the elderly will not be affected by increases in fuel prices, the government proposes to compensate them in such an event. Accordingly, it will pay the elderly the difference between the higher price and the current price for the original level of consumption.

Describe the initial choice of heating by an elderly individual;

Analyse the effects of an increase in the cost of heating on the consumption of heating and the well-being of that individual before and after the implementation of government policy;

Will the policy be effective in maintaining the initial level of heating in the case of an increase in the price of heating?

Will your answer to (c) depend on whether heating is a normal or inferior good?

Critics of the government argued that such a policy will not achieve its objectives.

Instead, they proposed either a subsidy that will keep the price of heating at its original level or, a subsidy for the actual desired level of heating (say, x1>x0 where x0 is the original level of fuel for heating consumption). Compare the effects of these two proposals to those achieved by the government policy and comment on the critics' claim.