Finance:Throw away paradox
In economics, the throw away paradox is a situation in which a person can gain by throwing away some of his property. It was first described[citation needed] by Robert J. Aumann and B. Peleg[1] as a note on a similar paradox by David Gale.[2]
Description
There is an economy with two commodities (x and y) and two traders (e.g. Alice and Bob).
- In one situation, the initial endowments are (20,0) and (0,10), i.e, Alice has twenty units of commodity x and Bob has ten units of commodity y. Then, the market opens for trade. In equilibrium, Alice's bundle is (4,2), i.e, she has four units of x and two units of y.
- In the second situation, Alice decides to discard half of her initial endowment - she throws away 10 units of commodity x. Then, the market opens for trade. In equilibrium, Alice's bundle is (5,5) - she has more of every commodity than in the first situation.
Details
The paradox happens in the following situation. Both traders have the same utility function with the following characteristics:
- It is a homothetic utility function.
- The slope of the indifference curves at [math]\displaystyle{ (y,y) }[/math] is -1.
- The slope of the indifference curves at [math]\displaystyle{ (2y,y) }[/math] is -1/8.
One such function is [math]\displaystyle{ u(x,y)=\frac{1}{(x+ay)^{-3}+(ax+y)^{-3}} }[/math], where [math]\displaystyle{ a }[/math] is a certain parameter between 0 and 1, but many other such functions exist.
The explanation for the paradox is that when the quantity of x decreases, its price increases, and the increase in price is more than sufficient to compensate Alice for the decrease in quantity.
See also
- Paradox of Plenty
- Resource monotonicity
References
- ↑ Aumann, R.J.; Peleg, B. (1974). "A note on Gale's example". Journal of Mathematical Economics 1 (2): 209. doi:10.1016/0304-4068(74)90012-3.
- ↑ Gale, David (1974). "Exchange equilibrium and coalitions". Journal of Mathematical Economics 1: 63–66. doi:10.1016/0304-4068(74)90036-6.
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