Endowment effect
Initial endowment
Suppose that our individual/consumer has an initial endowment of only one good. Assuming the initial e endowment of good 1 is e and 0 initial endowment of good 2. The point of initial endowment must represent a positive amount of good 1 and 0 of good 2. So, the point of initial endowment is on the horizontal axis.
Effects of price increase on the budget line
Suppose the price of good 1 increases, the slope of the budget line increases. The slope increases in absolute value and it still goes through e. Now you can immediately see that our budget set has widened or enlarged. The price of good 1 increases and your income increases, so there are many more alternative consumption bundles that you may obtain. We might call this the endowment effect.
1̇* - > 0
2̇* - > 0
Consumer preferences
If he is more interested in good 2, he will sell part of good 1 (z) to purchase good 2. z is an important value that tells you what you want to consume over what you already have.
( ) = − = 1 1 1st st
Price and quantity demanded
We have the price of the 1st good which has increased and the quantity demanded of the 1st good has gone up, so this good has effectively behaved as a Giffen good. It must have been the case that the income effect is positive and it is positive enough to beat the substitution effect which is negative.
A side to side comparison with the price effect
| Components | Price effect | Endowment effect |
|---|---|---|
| Budget line | Constructed from income | Constructed from the price of two endowments e and e12 |
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![Managerial economics guide 2]()
Managerial economics guide 2
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![Managerial economics guide 1]()
Managerial economics guide 1
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![Managerial economics guide 4]()
Managerial economics guide 4
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![Managerial economics guide 5]()
Managerial economics guide 5
Recensioni
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