Question

Explain and draw a graph to show the effects on supply, demand, and equilibrium price in the indicated markets when the following events occur. The asterisk indicates the event with the larger magnitude.

1. Coffee market: A drought causes costs of milk production to rise (milk products and coffee are consumption complements), and the price of oranges (a production substitute for coffee) rises*.
2. Gasoline market. The price of asphalt (a by-product of refining oil into gas) rises because of increased US spending on infrastructure, and cities begin turning more highways and streets into toll roads*.

Answer 1

i) As the cost of milk production rises and milk is an input for coffee, cost of producing coffee rises. Thus, the supply of cofffee decrease and supply curve shifts to the left. Again, price of oranges rises by a larger extent which decreases the demand for oranges and as coffee and oranges are substitutes, assuming the consumption remains same, people switches to coffee and demand for coffee increases by a larger extent. Therefore, in the coffee market, both price and quantity increases, as shown by the diagram below.

a Q1 Q2

ii) As people turn to make more toll roads, the demand for gasoline decreases significantly as people will travel more by public transport to avoid paying extra toll. The supply of Gasoline will increase due to higher production of its by-product due to increased demand. Thus both price and quantity decreases, as is shown in the diagram below.

20 a Q2 Q1