05/04/2012 § Leave a comment
Easter is almost upon us, reminding me of my early lessons in endowments, preferences, and Pareto optimisation. I’m talking, of course, about trading Easter candy.
Now, parents have an impossible task. They can either give every child exactly the same endowment of candy (jelly beans, chocolate eggs, marshmallow chicks, etc.), or they can attempt to equalise the satisfaction of the children by matching endowments to known preferences.
I come from a big family. Easter morning, our baskets of candy would be waiting for us, delivered overnight by the Easter bunny. In a small family, it is possible to spend more time giving each child what they want. In a big family, everybody just needs to get in line and accept what they get.
So, we all had pretty much the same baskets. As a result, once the chocolate bunnies were eaten, we were each left with candy we didn’t particularly like. There was scope for Pareto improvement — each one of us could be better off and no one worse off by engaging in free trade. I was the only one who liked black jelly beans, so that was my ace in the hole. I was pretty much the monopsony buyer of black jelly beans. On the other hand, I don’t particularly care for marshmallow chicks, so I was happy to get rid of them. Also, as an older child, I had a bit of an advantage over my less experienced siblings.
Of course, candy is candy, even if it isn’t the best. Each piece still has a minimum sugar value. This sugar value functioned as a reserve price in the barter process.
What did I learn from all this?
- heterogeneity of preferences can be a strong driver of trade
- failures in initial endowments can be corrected through open markets
- information is powerful — use it to your advantage
- the trade price is indeterminate, so try to find your partner’s reserve price.
When I say that trades were Pareto improving, that’s a technical term. It doesn’t mean there weren’t arguments and even tears. But that’s all part of the information discovery process, right? And, as much as everyone was better off, I have to admit that I might have been a bit betterer off. What can I say? That’s what big brothers do.