Additionally we will assume that each producer

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Unformatted text preview: amounts of capital and labour originally owned by consumer A and KB , LB denote the amounts of capital and labour originally owned by consumer B. 129 The total (or market supply) of capital and labour owned by both consumers are: KT = KA + KB LT = LA + LB How does this factor endowment distribution affect the consumer optimizing behavior? The interesting part of the factor endowment distribution is that the endowments of each consumer need to be determined at market prices. They can fluctuate along with market prices and hence, influence each consumer's decision in other markets. For example, if wage increases then the consumers' endowment incomes will increase accordingly. Under normal circumstances we would expect that, with more income in their hands, consumers will increase their demands for the goods. This triggers an increase in the production of goods which, on turn, feeds back to the demand for factors and ultimately back to the income side. Let's look at how the factor endowments enter the utility maximization problems of both consumers A and B. CONSUMER A decisions utility XA , YA UA = UA(XA,YA) CONSUMER B decisions utility XB , YB UB = UB(XB,YB) endowments KA , LA prices income PX , PY MA = r KA + w LA endowments KB , LB prices income PX , PY MB = r KB + w LB Note that the endowment income, MA, is also a function of prices, r , w. Utility Maximization maximize UA(XA,YA) subject to PX XA + PY YA = MA Note that endowment income, MB, is also a function of prices, r , w. Utility Maximization maximize UB(XB,YB) subject to PX XB + PY YB = MB 130 Consumer Equilibrium Analytically, the two conditions for consumer equilibrium must be satisfied: MRSA = PX PY PX XA + PY YA = MA Solving these two equations for XA & YA we get the demands by consumer A. XA = XA(PX, PY, MA) YA = YA(PX, PY, MA) Since the endowment income, MA, is a function of factor prices, r, w, we can eliminate MA and express the consumer demands in terms of prices (PX, PY, r, w) alone. XA = XA(PX, PY, r, w) YA = YA(PX, PY, r, w) Consume...
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This note was uploaded on 05/25/2010 for the course ECON 301 taught by Professor Sning during the Spring '10 term at University of Warsaw.

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