Buying and Selling
In previous chapters, we studied the behavior of con-
sumers who start out without owning any goods, but who had some money
with which to buy goods. In this chapter, the consumer has an
, which is the bundle of goods the consumer owns before any
trades are made. A consumer can trade away from his initial endowment
by selling one good and buying the other.
The techniques that you have already learned will serve you well here.
To Fnd out how much a consumer demands at given prices, you Fnd his
budget line and then Fnd a point of tangency between his budget line and
an indi±erence curve. To determine a budget line for a consumer who
is trading from an initial endowment and who has no source of income
other than his initial endowment, notice two things.
endowment must lie on the consumer’s budget line
no matter what the prices are, the consumer can always a±ord his initial
if the prices are
, the slope of the budget
line must be
This is true, since for every unit of good 1 the
consumer gives up, he can get exactly
units of good 2. Therefore
if you know the prices and you know the consumer’s initial endowment,
then you can always write an equation for the consumer’s budget line.
After all, if you know one point on a line and you know its slope, you
can either draw the line or write down its equation. Once you have the
budget equation, you can Fnd the bundle the consumer chooses, using the
same methods you learned in Chapter 5.
A peasant consumes only rice and Fsh. He grows some rice and
some Fsh, but not necessarily in the same proportion in which he wants
to consume them. Suppose that if he makes no trades, he will have 20
units of rice and 5 units of Fsh. The price of rice is 1 yuan per unit, and
the price of Fsh is 2 yuan per unit. The value of the peasant’s endowment
20) + (2
5) = 30. Therefore the peasant can consume any bundle
) such that (1
) = 30.
Perhaps the most interesting application of trading from an initial
endowment is the theory of labor supply.
To study labor supply, we
consider the behavior of a consumer who is choosing between leisure and
The only thing that is at all new or “tricky” is Fnding
the appropriate budget constraint for the problem at hand. To study
labor supply, we think of the consumer as having an initial endowment of
leisure, some of which he may trade away for goods.
In most applications we set the price of “other goods” at 1. The
wage rate is the price of leisure. The role that is played by income in
the ordinary consumer-good model is now played by “full income.” A
worker’s full income is the income she would have if she chose to take no