Question

EXERCISE 5.8 TAKE IT OR LEAVE IT?

Why is it Bruno, and not Angela, who has the power to make a take-it-or-leave-it offer? Can you imagine a situation in which the farmer, not the landowner, might have this power?

Answer 1

Suppose that Bruno could not force Angela to work a particular number of hours (because, for example, he lives far away, and cannot observe what she is doing). But he can charge rent of a number of bushels for her use of the land. What rent will he charge?

Bruno will choose the rent that maximises the amount of grain he gets, while taking into account the fact that Angela will not accept any offer below her reservation indifference curve. The maximum feasible rent is therefore five-and-a-half bushels of grain, which is equal to the maximum amount of grain Bart can get when exchange is voluntary (see Figure 1). The imposition of maximum rent by Bruno is shown by the downward shift of the feasible consumption frontier in Figure 2. Point A, where Angela is working for nine hours, is the best that she can do when Bruno is charging maximum rent. At this point she is on her reservation indifference curve, so is indifferent between accepting the offer and refusing the offer and living on government rations.We will suppose that Bruno charges a tiny bit less rent than this, so she accepts.