Question

Assume Economy A produces coffee.

a) In the space provided below show the coffee market by graphing the coffee demand and supply curves. Label the Demand curve D1, Supply curve S1, Equilibrium point E1, Price Equilibrium P1, and Quantity Equilibrium Q1, both axis. (2 points)

Now assume that prices of tea drops, (tea is considered a substitute for coffee) while coffee beans (a resource for coffee) price also drops.

b) In sentences, describe what will happen to market supply and market demand for coffee. In the graph above, denote these changes if any with D2 for Demand curve two, S2 for Supply curve two, P2 for price equilibrium 2, E2 for equilibrium quantity, and Q2 for quantity equilibrium. (5 points)

c) In sentences, describe what will happen to price equilibrium and quantity equilibrium of coffee with these changes.   ( 3 points)

Answer 1

The coffee market is shown below where equilibrium price is P1, and equilibrium quantity is Q1,

When the prices of tea drops, where tea is a substitute for coffee, quantity demanded for tea rises and demand for coffee decreases. This is expected to shift the demand curve for coffee to the left and the equilibrium price reduces along with the quantity at the new equilibrium.

At the same time, coffee beans, a resource for coffee, experience a decline in its price. There is a reduction in cost of production so supply increases. This is expected to shift the supply curve for coffee to the right and the equilibrium price reduces but the quantity rises at the new equilibrium.

We have assumed that the size of the two shifts is same. Due to this, the rise in quantity due to supply shift equally matches with the fall in price with the demand shift so eventually there is no change in the quantity. However, the price does fall in both conditions.

Price S1 S2 El P1 P2 D1 Quantity Q1