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=p11+p22
 Budget line in terms of net demands
p1(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 1
x1>1
Net seller of good two
x2<2
9.3 Changing the Endowment

Budget line shifts inward
p11  p22  p11  p22

Budget line shifts outward
p11  p22  p11  p22
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 effect
 when
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 effect
 an
extra income effect from the influence of the
prices on the value of the endowment bundle.
9.6 The Slutsky Equation Revisited
m  p1 x1  p2 x2  p11  p22
m  p1x1  p2 x2
m  p11  p22
m  m  m  m  m  m  m
 ( p1  p1 )1  ( p1  p1) x1
 ( p1  p1 )(1  x1 )
 p1 (1  x1 )
9.6 The Slutsky Equation Revisited
x1  x1 ( p1, m)  x1 ( p1 , m)
 x1 ( p1, m)  x1 ( p1, m)  x1 ( p1, m)  x1 ( p1 , m)
 x  x
n
1
s
1
x1 x x
x x m




p1 p1 p1 p1 m p1
s
1
n
1
s
1
x x


(1  x1 )
p1 m
s
1
n
1
n
1
9.6 The Slutsky Equation Revisited




x1 x1s x1n
x1n


x1 
1
p1 p1 m
m
x1
Total change in demand
p1
x1s
Substitution effect
p1
n
x1
Ordinary income effect 
x1
m
n

x
1
Endowment income effect
1
m
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.
x1 x1s x1n


(1  x1 )
p1 p1 m
()
(  ) ( )
9.8 Labor Supply






Non-labor income: M
Budget constraint: pC  M  wL
M
Endowment of the consumption good: C 
p
Endowment of labor: L
Budget constraint: pC  wl  pC  wL
Real wage is the opportunity cost of leisure.
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