Question

Analyze the effects of several “shocks” to the market for coffee. Choose one of the three scenarios below.

Scenario 1: Suppose that, as part of an international trade agreement, the U.S. government reduces the tariff on imported coffee. Will this affect the supply or the demand for coffee? Why? Which determinant of demand or supply is being affected? Show graphically with before- and after-curves on the same axes. How will this change the equilibrium price and quantity of coffee? Explain your reasoning.

Scenario 2: Suppose the National Institutes of Health publishes a study finding that coffee drinking reduces the probability of getting colon cancer. How do you imagine this will affect the market for coffee? Why? Which determinant of demand or supply is being affected? Show graphically with before- and after-curves on the same axes. How will this change the equilibrium price and quantity of coffee? Explain your reasoning.

Scenario 3: Combine parts 1 and 2. Suppose that the U.S. government reduces the tariff on imported coffee, and a reputable study is published indicating that coffee drinkers have lower rates of colon cancer. What will the combined impact be on the equilibrium price and quantity of coffee? Explain your reasoning and show graphically. Make sure you think this through carefully!

Answer 1

Scenario 1. If the US government reduces the tariffs on imported coffee, this will lead to increase in the supply of coffee will increase in US market because reduced tariff will reduce the cost for importers. This will lead to the rightward shift in the supply curve and demand curve will stay the same. As a result equilibrium quantity will increase and equilibrium price will fall. Initial equilibrium was at point A with quantity Q* and price P* after US government reduces tariffs the supply curve shifts to the right and the new equilibrium is at point B with equilibrium quality Q' and price P'.

The equilibrium price falls and equilibrium quantity increases.

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Scenario 2. If study funding states that drinking coffee reduces the probability of having a colon cancer this will create positive impact on the consumers of consuming more coffee as a result this will lead to a rightward shift of demand curve. The increase demand will lead to higher prices and higher quantity at new equilibrium.

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Initially the original demand curve was DD and supply curve was SS. The equilibrium was at point A where equilibrium quantity was Q* and price was P*. After the study got published the demand for coffee increases indicated by the right ward shift in demand curve. The new demand curve is DD' and the new equilibrium shifts to point B where the equilibrium price is P' and equilibrium quantity is at Q'.

The equilibrium price increases and quantity also increases.

Scenario 3. In this case both demand and supply curve will shift

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As you can see above the initial demand and supply curve was DD and SS respectively and the equilibrium was at point A where equilibrium quantity and price is Q* and P* respectively. After the reduction in tariffs the supply curve shifts right wards at SS' and as study got published the demand curve shifts to the right to DD' and now new equilibrium is at point B where the equilibrium quantity is at Q' and price remains the same as before at P*.

In this scenario equilibrium quantity increases while price remains the same.

Note: Infact the changes in the supply and demand curve will depend on the elasticities of the curves.