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Chapter 18 / Trading from an Endowment

18.1 Trading Applications

In Part II of this book, we examined the problem of a consumer with a certain amount of money to spend on two goods. However, there’s an important and broad class of economic problems that involve agents who start with an “endowment” of goods, rather than a set amount of money. They can then trade goods with other agents, either by direct barter or by selling off some of their endowment for money and using that money to buy other goods, to end up with a bundle they prefer. The diagram below shows this kind of contract; drag the two bundles around to get an intuition for the kind of transaction we’ll be discussing:

In this Part we’ll first derive the core theory of trading from an endowment, and then apply that theory to three important situations. In each, “good 1” and “good 2” take on different meanings than just goods like apples and oranges:

These three examples aren’t incidental to the study of economics: indeed, they form the basis of labor economics, financial economics, and other major fields of applied theory! And yet, at their core, they all come down to the same simple problem of trading from an endowment.

It’s worth emphasizing that trades, or contracts more generally, do not necessarily require buying and selling at market prices. In some cases it’s even illegal for money to change hands: politicians trade votes all the time (a procedure known as “logrolling”) even though it would be corrupt or unethical to outright sell a vote for money. And even when money is involved, contracts do not need to be expressed in a unit price: in a labor context, while some people choose to sell their labor at an hourly wage, others work for a fixed salary. Economists are interested in all of these kinds of exchange behavior; but this chapter we’ll analyze the specific instance of how an agent starting from an endowment responds to market prices, before moving on to more nuanced examples in the applications described above.

Next: Endowment budget lines
Copyright (c) Christopher Makler /