Buying and Selling

Question 1

What is endowment?

Answer 1

• Endowment (ω) is the list of resource units with which a consumer starts with [wealth]
• The endowment can be exchanged for any bundle that costs no more than the endowment’s value

Question 2

Using the endowment equation, what is in the budget set?

Answer 2

• { (X1,X2) | p1X1 + p2X2 ≤ p1ω1 + p2ω2 } when X1 and X2 are greater than 0

Question 3

What happens when endowment increases?

Answer 3

• Consumers are BETTER off
• Budget line shifts OUTWARDS
• MORE EXPENSIVE bundles can be purchased

Question 4

What happens when endowment decreases?

Answer 4

• Consumers are WORSE off
• Consumption patterns change (Normal -> Inferior)

Question 5

What happens to the endowment when price decreases (graphically)?

Answer 5

• The budget constraint pivots around the endowment point

Question 6

What happens to SUPPLIERS/BUYERS when the price of a good decreases?

Answer 6

• If the person is a SELLER, they are worse off, so they will be on a lower indifference curve
• If the person is a BUYER, they are better off, so they will be on a higher indifference curve

Question 7

What are Net Demands?

Answer 7

• The difference between the consumer’s gross demand and the endowment
• What you have to give up of good Y in order to purchase more good X

Question 8

How does Labour Supply coincide with endowment? What are workers endowed?

Answer 8

• Workers are endowed with $m of non-labour income and R hours of time
• Therefore, ω = (R,m)

Question 9

What is the worker’s budget constraint? How can the overall line be derived

Answer 9

• Pc = m + wL, which gives m = Pc - wL
• If L Bar = maximum that can be supplied, adding wL Bar to both sides:
  m + wL Bar = pC + w(L Bar - L)
• If C Bar = m / P, meaning C Bar is the potential consumption with zero work
• If R Bar = L Bar, as R = L Bar - L
• THEN :
  pC + wR = pC Bar + wR Bar

Question 10

Explain the Labour Supply endowment diagram

Answer 10

• Budget line equation: c = -w/P * R + [pC Bar + wR Bar] / P
• w/P is the real wage rate
• (C * , R * ) is the point where the indifference curve cuts the budget constraints
• Left of R * is leisure time, Right of R * is labour time
• (C Bar, R Bar) is where the line ends [i.e. 24 hours]

Question 11

What happens to R when M increases ?

Answer 11

• R increases, as Leisure is a normal good

Question 12

What happens to R when w increases?

Answer 12

• Leisure becomes more expensive
• There is a drop in the demand for leisure (SUBSTITUTION effect)
• Returning to work increases as the supply of labour rises (SUBSTITUTION effect)

Question 13

Expand on what happens to the budget constraint when w increases (effects on ENDOWMENT)

Answer 13

• There is a substitution effect
• An ENDOWMENT income effect, as well as the regular income effect
• The endowment income effect: Changes in price has an influence on the value of the endowment bundle, having an impact on the Labour Supply curve