CH 09 Buying Selling

Buying and Selling
Trade/exchange (交易/以物易物):
when something is bought,
something else must be sold.
What will be bought/sold?
Who will be the buyer/seller?

Endowments
The commodities with which a
consumer starts is his endowment.
A consumer’s endowment will be


denoted by the vector .
Endowments
For example,
 = ( 1 , 2 ) = (1 0 ,2 )
denotes that the consumer is endowed

initially with 10 units of good 1 and 2
units of good 2.
Value of Endowments
If p1=2 and p2=3, the value of the
endowment (  1 ,  2 ) = ( 1 0 , 2 ) is
p 1 1 + p 2  2 = 2  1 0 + 3  2 = 2 6
Q: Which consumption bundles may
the endowment be exchanged for?
A: Any bundle costing no more than
the endowment’s value (i.e., feasible).
Budget Constraints
Given p1 and p2, the budget constraint
for a consumer with endowment (  1 ,  2 )
is:
p 1 x 1 + p 2 x 2 = p 1 1 + p 2  2 .
The budget (feasible) set is then:
( x1 , x 2 ) p 1 x 1 + p 2 x 2  p 1 1 + p 2 2 ,
x 1  0 , x 2  0 .
Budget Constraints
x2
Budget constraint:
p 1 x 1 + p 2 x 2 = p 1 1 + p 2  2
2 Budget set:
 ( x 1 , x 2 ) p 1 x 1 + p 2 x 2  p 1 1 + p 2 2 ,
x 1  0 , x 2  0
x1
1
Budget Constraints
x2
p 1 x 1 + p 2 x 2 = p 1 1 + p 2  2
2 Budget set for (p1’, p2’)

p 1 x 1 + p 2 x 2 = p 1 1 + p 2  2
' ' ' '
x1
1
Budget Constraints
x2
The endowment point is always on
the budget constraint.
p 1 x 1 + p 2 x 2 = p 1 1 + p 2  2
So, price changes pivot

2 the constraint about the
endowment point.
p '1 x 1 + p '2 x 2 = p '1 1 + p '2  2
x1
1
Budget Constraints
The constraint
p 1 x 1 + p 2 x 2 = p 1 1 + p 2  2
can also be written as:
p1(x1 −  1 ) + p 2(x 2 −  2 ) = 0.
Therefore, the total value of a
consumer’s net demands is zero.
Net Demands #1
x2
p1(x1 −  1 ) + p 2(x 2 −  2 ) = 0
x2* At prices (p1,p2) the consumer

sells units of good 1 to acquire
2 more units of good 2.
x1
x1* 1
Net Demands #2
x2
At prices (p1’,p2’) the consumer
sells units of good 2 to acquire
more of good 1.
p '1 x 1 + p '2 x 2 = p '1 1 + p '2  2
2
x2*
1 x1*
x1
Net Demands #3
x2
p1(x1 −  1 ) + p 2(x 2 −  2 ) = 0
At prices (p1”, p2”) the consumer
consumes her endowment; net
demands are all zero.
x2*=2 p "1 x 1 + p "2 x 2 = p "1  1 + p "2  2
x1
x1*=1
Price-Offer Curve
x2 Price-offer curve contains all
the utility-maximizing gross
demands for which the
endowment can be traded.
2
x1
1
Price-Offer Curve
x2
2 becomes cheaper:
Sell good 1, buy good 2
2
x1
1
Price-Offer Curve
x2
1 becomes cheaper:
Buy good 1, sell good 2
2
x1
1
Labor Supply
A worker is endowed with $m of

⎯
non-labor income and R hours of
time which can be used for labor
or leisure:
⎯
 = (R,m)
Consumption good’s price: pc
Wage rate: w
Full-income Budget Constraint
The worker’s budget constraint is
⎯
p c C = w (R − R ) + m
where:
C = gross demand for good
R = gross demand for leisure
then: p c C + w R = w ⎯
R +m


Total Full endowment
expenditure value
Labor Supply
Further rearrangement:
⎯
w m + wR
C=− R+ .
pc pc
Full-Income Budget Constraint
⎯
w m + wR
C C=− R+
pc pc
⎯
m + wR
pc w
slope = − , the real wage rate
pc
endowment
m/pc
⎯ R
R
Labor Supply
C ⎯
w m + wR
⎯
m + wR C=− R+
pc pc pc
C*
endowment
m/pc
⎯ R
R* R
leisure labor supplied
demanded
Slutsky Equation Revisited
Slutsky: changes to demands caused by a

price change are the sum of
– a pure substitution effect
– an income effect
This assumed that income y is fixed as
prices changed. But now, endowment
y = p 1 1 + p 2  2
does change with price.
A change in p1 or p2 changes
y = p 1  1 + p 2  2 , so there will be
an additional income effect, called
the endowment income effect.
Slutsky’s decomposition will thus
have three components:
– pure substitution effect
– (ordinary) income effect
– endowment income effect
x2
Initial prices are (p1, p2)

Initial demands are (x1,x2)
x2
2
x1 1 x1
x2
Prices change to (p1’, p2)
How to decompose the change

from (x1, x2) to (x1’, x2’)?
x2
2
X2’
x1
x1 1 X1’
 Pure substitution effect

x2
 Ordinary income effect
 Endowment income effect
2
x1
1
Overall, change in demand caused by a

change in price is the sum of:
(1) a pure substitution effect
(2) an ordinary income effect
(3) an endowment income effect

CH 09 Buying Selling

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Buying and Selling

What will be bought/sold?

Who will be the buyer/seller?

A consumer’s endowment will be

denotes that the consumer is endowed

2 Budget set for (p1’, p2’)

So, price changes pivot

x2* At prices (p1,p2) the consumer

A worker is endowed with $m of

Slutsky: changes to demands caused by a

Initial prices are (p1, p2)

How to decompose the change

 Pure substitution effect

Overall, change in demand caused by a

(1) a pure substitution effect

(2) an ordinary income effect

(3) an endowment income effect

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