Lecture 11 handout - Endowment Income Effect and Labor Supply

Lecture 11 handout - Endowment Income Effect and Labor Supply

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Unformatted text preview: 1 Buying and Selling So far, we’ve been assuming that the individual enters the market with a certain amount of wealth , but does not already own any of the goods. This is true of most of us, for example, when we’re shopping for groceries. Now we’re going to think about the case where the individual already owns some of the goods before entering the market. One situation where this is true is when you are a producer . For example, an apple farmer produces apples. The apples the farmer produces are a major source of the farmer’s wealth, and the farmer sells apples to generate the money to buy other things. Yet the farmer may be a consumer of apples at the same time. Hence the farmer enters the market for apples with a large endowment of apples. Another situation where this is true occurs with durable goods: goods that produce a f ow of services over time. For example, a house is a durable good because you after you buy it, you can get utility from it over a long period of time. Other examples of durable goods are cars, jewelry, and washing machines. (In contrast, a non-durable good provides services over a short period of time. Examples include a hamburger, a cigarette, and a cup of co f ee.) With a durable good like a house or car, most people sell their old one when they buy a new one. Hence an individual enters the housing market with some endowment of housing services. The amount of the two goods that you already own before you buy or sell is called your endowment : ( 1 2 ) . If you have an endowment of the goods and no other source of wealth, then your wealth is 1 1 + 2 2 . Hence your budget constraint with an endowment is 1 1 + 2 2 ≤ 1 1 + 2 2 Therefore, holding constant prices, a change in your endowment is equivalent to a change in wealth, and changes your budget constraint exactly that way. When you have an endowment, the total amount of Good 1 you choose to have is called your gross demand for Good 1: ∗ 1 . Your net demand is the di f erent between your gross demand and the amount you started with: ∗ 1 − 1 . An individual is a net buyer of Good 1 if the individual’s net demand is positive: ∗ 1 − 1 ....
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Lecture 11 handout - Endowment Income Effect and Labor Supply

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