Homework #2

Raymond Deneckere

(For student use only; Copyright c 2018)

1. Consider a market for the exchange of an homogenous indivisible good, of which each trader is

willing to purchase at most one unit, and each trader is endowed with at most one unit. More

speci…cally, suppose that there are N + M traders, and that M traders are endowed with one

unit of the indivisible good. Let trader’s valuations be ranked as follows: v1 v2 vN +M .

There is also a perfectly divisible medium of exchange between traders called money. Assume

that each trader’s money holdings are large enough that (s)he is always able to purchase a

unit, if (s)he so desires.

(a) Formulate a proposition that describes the Pareto optimal holdings of the indivisible

good.

(b) Demonstrate how this formulation of the problem of multilateral exchange is equivalent

to approach described in class.

2. Consider the …xed fee monopoly brokerage model discusses in class. Let M = N = 3. The

respective valuations are:

1 2 3

Buyer 10 6 4

Seller 1 3 5

(a) Determine the broker’s optimal trading volume as a function of the …xed fee .

(b) Suppose that the broker’s cost per transaction is given by k = 2. Determine the brokers’s

pro…t as a function of , and …nd the transaction fee that maximizes the broker’s pro…t.

1
 (c) Is the broker’s matching that support the solution in part (b) uniquely determined?

Explain.

(d) Compare the solution in part (b) with the socially optimal solution. Explain your answer.

3. Consider a market for the exchange of an indivisible good, in which there is a single buyer

willing to purchase at most one unit, and a single seller, who is able to supply at most one

unit. The buyer’s valuation is v, and his money holdings equal m. The seller’s cost equals c.

Assume that a transaction can take place only if the buyer is able to pay the seller’s cost, i.e.

if m c.

a) Describe the most e¢ cient non-random feasible allocation.

b) Could a random allocation in which the good is transferred with probability p, where

0 < p < 1 improve the e¢ ciency of the market?