Chapter Nine Buying and Selling. Endowments u The list of resource units with which a consumer starts is his endowment. u A consumer’s endowment will.
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Presentation on theme: "Chapter Nine Buying and Selling. Endowments u The list of resource units with which a consumer starts is his endowment. u A consumer’s endowment will."— Presentation transcript:
Budget Constraints Revisited x2x2 x1x1 The endowment point is always on the budget constraint. So price changes pivot the constraint about the endowment point.
Budget Constraints Revisited u The constraint is u That is, the sum of the values of a consumer’s net demands is zero.
Net Demands u Suppose and p 1 =2, p 2 =3. Then the constraint is If the consumer demands (x 1 *,x 2 *) = (7,4), then 3 good 1 units exchange for 2 good 2 units. Net demands are x 1 *- 1 = 7-10 = -3 and x 2 *- 2 = 4 - 2 = +2.
Net Demands p 1 =2, p 2 =3, x 1 *- 1 = -3 and x 2 *- 2 = +2 so The purchase of 2 extra good 2 units at $3 each is funded by giving up 3 good 1 units at $2 each.
Net Demands x2x2 x1x1 x2*x2* x1*x1* At prices (p 1,p 2 ) the consumer sells units of good 1 to acquire more units of good 2.
Net Demands x2x2 x1x1 x2*x2* x1*x1* At prices (p 1 ’,p 2 ’) the consumer sells units of good 2 to acquire more of good 1.
Net Demands x2x2 x1x1 x 2 *= x 1 *= At prices (p 1 ”,p 2 ”) the consumer consumes her endowment; net demands are all zero.
Slutsky’s Equation Revisited u Slutsky: changes to demands caused by a price change are the sum of –a pure substitution effect, and –an income effect. u This assumed that income y did not change as prices changed. But does change with price. How does this modify Slutsky’s equation?
Slutsky’s Equation Revisited u A change in p 1 or p 2 changes so there will be an additional income effect, called the endowment income effect. u Slutsky’s decomposition will thus have three components –a pure substitution effect –an (ordinary) income effect, and –an endowment income effect.