Chapter Nine discusses the concepts of buying and selling, focusing on how trade involves the exchange of goods and the generation of income based on commodity prices. It explains the importance of endowments, budget constraints, and net demands in understanding consumer behavior and market dynamics. Additionally, it revisits Slutsky's equation, detailing how price changes affect demand through substitution and income effects, including the newly introduced endowment income effect.
Chapter Nine discusses the concepts of buying and selling, focusing on how trade involves the exchange of goods and the generation of income based on commodity prices. It explains the importance of endowments, budget constraints, and net demands in understanding consumer behavior and market dynamics. Additionally, it revisits Slutsky's equation, detailing how price changes affect demand through substitution and income effects, including the newly introduced endowment income effect.
Chapter Nine discusses the concepts of buying and selling, focusing on how trade involves the exchange of goods and the generation of income based on commodity prices. It explains the importance of endowments, budget constraints, and net demands in understanding consumer behavior and market dynamics. Additionally, it revisits Slutsky's equation, detailing how price changes affect demand through substitution and income effects, including the newly introduced endowment income effect.
Chapter Nine discusses the concepts of buying and selling, focusing on how trade involves the exchange of goods and the generation of income based on commodity prices. It explains the importance of endowments, budget constraints, and net demands in understanding consumer behavior and market dynamics. Additionally, it revisits Slutsky's equation, detailing how price changes affect demand through substitution and income effects, including the newly introduced endowment income effect.
Buying and Selling Trade involves exchange -- when something is bought something else must be sold. What Wh will ill be b bought? b h ? What Wh will ill be b sold? Who will be a buyer? Who will be a seller? Buying and Selling And how are incomes generated? How does the value of income depend upon commodity prices? How can we put all this together to explain better how price changes affect demands? Endowments The list of resource units with which a consumer starts is his endowment. endowment A consumer’s endowment will be d denotedd by b the h vector (omega). ( ) Endowments E.g. (1,2) (10,2) states that the consumer is endowed with 10 units of good 1 and 2 units of good 2. 2 Endowments E.g. (1,2) (10,2) states that the consumer is endowed with 10 units of good 1 and 2 units of good 2.2 What is the endowment’s value? For which consumption bundles may it be exchanged? Endowments p1=2 and p2=3 so the value of the endowment (1,2) (10,2) is p11 p22 210 3 2 26 Q: For which consumption bundles may the endowment be exchanged? A: For any bundle costing no more than the endowment’s value. Budget Constraints Revisited So, given p1 and p2, the budget So constraint for a consumer with an endowment (1,2) is p1x1 p2x2 p11 p22. The budget set is (x1,x2) p1x1 p2x2 p11 p22, x1 0, x2 0. Budget Constraints Revisited x2
p1x1 p2x2 p11 p22
x1 Budget Constraints Revisited x2
p1x1 p2x2 p11 p22
Budget g set (x1,x2) p1x1 p2x2 p11 p22, x1 0, x2 0
x1 Budget Constraints Revisited x2
p1x1 p2x2 p11 p22
p'1x1 p'2x2 p1 ' 1 p'22
x1 Budget Constraints Revisited x2
p1x1 p2x2 p11 p22
Budget set
p'1x1 p'2x2 p1 ' 1 p'22
x1 Budget Constraints Revisited The endowment point is always on x2 the budget constraint. p1x1 p2x2 p11 p22
p'1x1 p'2x2 p1 ' 1 p'22
x1 Budget Constraints Revisited The endowment point is always on x2 the budget constraint. p1x1 p2x2 p11 p22 So price changes pivot the constraint about the endowment point. p'1x1 p'2x2 p1 ' 1 p'22
x1 Budget Constraints Revisited The constraint p1x1 p2x2 p11 p22 is p1(x1 1) p2(x2 2) 0.
That is, the sum of the values of a
consumer’s net demands is zero. Net Demands Suppose (1,2) (10,2) and p1=2, p2=3. Then the constraint is p1x1 p2x2 p11 p22 26 6. If the consumer demands (x1*,x2*) = (7 4) then 3 good 1 units exchange (7,4), for 2 good 2 units. Net demands are x1*- 1 = 7-10 = -3 and x2*- 2 = 4 - 2 = +2. Net Demands p1=2, 3, x1*-1 = -3 2, p2=3, 3 and x2*-2 = +2 2 so p1(x1 1) p2(x2 2) 2 (3) 3 2 0. The purchase Th h off 2 extra t good d 2 units it att $3 each is funded by giving up 3 good 1 units at $2 each. Net Demands x2 p1(x1 1) p2(x2 2) 0
At prices (p1,p p2) the consumer x 2* sells units of good 1 to acquire more units of good 2.2
x 1* x1 Net Demands x2
At prices (p1’,p p2’)) the consumer sells units of good 2 to acquire more of good 1.1 x 2* p1x1 p2x2 p11 p22 ' ' ' '
x 1* x1 Net Demands x2 p1(x1 1) p2(x2 2) 0
At prices (p1”,p p2”)) the consumer consumes her endowment; net demands are all zero. zero x2*=
p"x 1 1 p" x 2 2 p" 1 1 p22 "
x1*= x1 Net Demands x2 p1(x1 1) p2(x2 2) 0 Price-offer curve contains all the utility-maximizing gross demands for which the endowment can be exchanged.
x1 Net Demands x2 p1(x1 1) p2(x2 2) 0 Price-offer curve Sell good 1, buy good 2
x1 Net Demands x2 p1(x1 1) p2(x2 2) 0 Price-offer curve Buy good 1, sell good 2
x1 Labor Supply A worker is endowed with $m of nonlabor income and R hours of time which can be used for labor or l i leisure. = (R,m). (R ) Consumption p good’s g price p is pc. w is the wage rate. Labor Supply The worker’s budget constraint is pcC w(RR) m where CC, R denote gross demands for the consumption good and for leisure. That is pcC wR wRm expenditure endowment value Labor Supply pcC w(RR) m
rearranges g to w m wR C R . pc pc ($) Labor Supply C
m endowment
R R Labor Supply C w m wR C R pc pc
m endowment
R R Labor Supply C w m wR m wR C R pc pc pc
m endowment
R R Labor Supply C w m wR m wR C R pc pc pc w slope = , the ‘real wage rate’ pc
m endowment
R R Labor Supply C w m wR m wR C R pc pc pc C*
m endowment
R R* R lleisure i llabor b demanded supplied Slutsky’ss Equation Revisited Slutsky Slutsky: y changes g to demands caused by a price change are the sum of – a pure substitution effect effect, and – an income effect. This assumed that income y did not change as prices changed. changed But y p11 p22 does change d h with ith price. i How H does d this modify Slutsky’s equation? Slutsky’ss Equation Revisited Slutsky A change in p1 or p2 changes y p11 p22 so there will be an additional income effect effect, called the endowment income effect. Slutsky’s decomposition will thus p have three components – a pure substitution effect – an (ordinary) ( di ) income i effect, ff andd – an endowment income effect. Slutsky’ss Equation Revisited Slutsky x2 Initial p prices are (p1’,p ,p2’). )
x 2’
2
x 1’ 1 x1 Slutsky’ss Equation Revisited Slutsky x2 Initial p prices are (p1’,p ,p2’). ) Final prices are (p1”,p2”).
x 2’
2 x 2”
x 1’ 1 x 1” x1 Slutsky’ss Equation Revisited Slutsky x2 Initial p prices are (p1’,p ,p2’). ) Final prices are (p1”,p2”). How is the change in demand x 2’ from (x1’,x2’) to (x1”,x2”) explained?
2 x 2”
x 1’ 1 x 1” x1 Slutsky’ss Equation Revisited Slutsky x2 Initial p prices are (p1’,p ,p2’). )
x 2’
2
x 1’ 1 x1 Slutsky’ss Equation Revisited Slutsky x2 Initial p prices are (p1’,p ,p2’). ) Final prices are (p1”,p2”).
x 2’
2 x 2”
x 1’ 1 x 1” x1 Slutsky’ss Equation Revisited Slutsky x2 Pure substitution effect
