Reservation Price and Reservation Demand

Abstract

The simplest example of a reservation price is that price below which an owner will refuse to sell a particular object in an auction. Since the owner could always, in principle, enforce such a price by outbidding everyone else, this leads immediately to the more general concept of a reservation price as that price at which the owner of a fixed stock will choose to retain some given amount from that stock, rather than supply more, and of the amount retained as the owner’s ‘reservation demand’ at the price in question. Considering alternative hypothetical prices, one sees that the owner’s supply curve of the commodity can equally well be described as an ‘own (reservation) demand’ curve, where ‘supply’ and ‘own demand’ sum identically to the given stock. The same is naturally true of the market supply curve. Thus consider the standard example of the determination of the price of first-edition copies of a certain old book. A demand curve may be drawn up for those who at present own no copies. Taking account of each present owner’s reservation price (or prices for those who possess more than one copy), we may also draw up a supply curve. (Of course ‘supply’ by present owners may be negative at low prices.) Confrontation of the demand and supply curves will then show the market-clearing price. Equally, however, we could have drawn up the ‘reservation demand’ curve of present owners, summed it with the demand curve of non-owners and then confronted the ‘total’ demand curve with the given stock. Since ‘supply’ and ‘reservation demand’ sum identically to total stock, at every price, the alternative diagram inevitably shows the same market-clearing price as does the first; it does not show the number of books traded, however.

This chapter was originally published in The New Palgrave Dictionary of Economics, 2nd edition, 2008. Edited by Steven N. Durlauf and Lawrence E. Blume