Chapter 9 BUYING AND SELLING

9.1 Net and Gross Demands

Endowments : (1, 2) how much of the two goods the consumer has before he

enters the market. Gross demands: (x1, x2)

the amount of the goods that the consumer actually ends up consuming.

Net demand: (x1-1, x2-2) the difference between the gross demands and the initial

endowments.

9.2 The Budget Constraint

The value of the consumed bundle must be equal to the value of the endowments.

p1x1+p2x2=p11+p22

Budget line in terms of net demandsp1(x1-1)+p2(x2-2)=0

9.2 The Budget Constraint

The budget line passes through the endowment with a slope of -p1/p2.

Net buyer of good 1x1>1

Net seller of good twox2<2

9.3 Changing the Endowment

Budget line shifts inward

1 1 2 2 1 1 2 2p p p p

Budget line shifts outward

1 1 2 2 1 1 2 2p p p p

9.3 Changing the Endowment

9.4 Price Changes

Decreasing the price of good 1 If the consumer remains

a supplier of good 1 she must be worse off.

9.4 Price Changes

Decreasing the price of good 1 If a person was a

buyer of good 1, he remains a buyer and must be better off.

9.5 Offer Curves and Demand Curves

9.6 The Slutsky Equation Revisited

Ordinary income effectwhen a price falls, you can buy just as much of a

good as you were consuming before and have some extra money left over.

Endowment income effectan extra income effect from the influence of the

prices on the value of the endowment bundle.

9.6 The Slutsky Equation Revisited

1 1 2 2 1 1 2 2m p x p x p p

1 1 2 2m p x p x

1 1 2 2m p p

1 1 1 1 1 1

1 1 1 1

1 1 1

( ) ( )( )( )

( )

m m m m m m mp p p p xp p xp x

9.6 The Slutsky Equation Revisited

1 1 1 1 1

1 1 1 1 1 1 1 1

1 1

( , ) ( , )( , ) ( , ) ( , ) ( , )

n s

x x p m x p mx p m x p m x p m x p m

x x

1 1 1 1 1

1 1 1 1 1

1 11 1

1

( )

s n s n

s n

x x x x x mp p p p m p

x x xp m

9.6 The Slutsky Equation Revisited

Total change in demand

Substitution effect

Ordinary income effect

Endowment income effect

1 1 1 11 1

1 1

s n nx x x xxp p m m

1

1

sxp

1

1

xp

11

nxm

11

nx xm

9.6 The Slutsky Equation Revisited

9.7 Use of the Slutsky Equation

Price effect could be positive for a normal good if the consumer is a net supplier of the good.Substitution effect: negative;Ordinary income effect: negative;Endowment income effect: positive.

1 1 11 1

1 1

( )( )( ) ( )

s nx x x xp p m

9.8 Labor Supply

Non-labor income: M Budget constraint: Endowment of the consumption good: Endowment of labor: Budget constraint: Real wage is the opportunity cost of leisure.

pC M wL

LpC wl pC wL

MCp

9.8 Labor Supply

9.9 Comparative Statics of Labor Supply As wage rate increases, the endowment income effect

may finally dominate other effects.

EXAMPLE: Overtime and the Supply of Labor Consider a worker who has chosen to supply a

certain amount of labor L* when faced with the wage rate w.

Now suppose that the firm offers him a higher wage, w’>w, for extra time beyond L*.

Labor supply increase unambiguously.

EXAMPLE: Overtime and the Supply of Labor