Question

2. (15%) Use supply and demand curves to illustrate how each of the following events would affect the market equilibrium of coffee. a. an increase in the price of tea, a substitute good. b. an increase in average incomes (coffee is an inferior good) c. a decrease in the cost of labor used to farm coffee beans d. a series of rainstorms causes a depletion of the coffee bean crop

Answer 1

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2,

a. As tea and coffee are substitutes of each other, an increase in the price of tea will lead to an increase in the demand for coffee as people will switch to coffee because tea has become expensive.

This can be shown in a supply and demand diagram. Figure 1 represents the equilibrium in the tea market.

Now initially supply and demand curve intersects at point A representing the equilibrium price and quantity of coffee. Now as the price of the substitute ( tea) increases, the demand curve for coffee will shift rightward. As a result of which at the new equilibrium point B, the price of coffee is higher than at point A and also quantity demanded will also rise from Q0 to Q1. ( refer figure 1)

b. Inferior goods are referred to those goods whose demand falls when the average income increases.

Now here coffee is an inferior good meaning that as the average income of a consumer increases, he will switch to other kinds of drinks rather than coffee. So as the average income increases, demand for coffee will decline.

From figure 2 we can see that due to an increase in the average income demand for coffee falls which is represented by the leftward shift of the demand for the coffee curve. Now at a new equilibrium, that is at point B, the equilibrium price of coffee falls from P0 to P1 while the equilibrium quantity demanded also falls from Q0 to Q1. ( refer to figure 2)

C. Now a decrease in the cost of labour used to farm coffee beans means a decrease in the cost of producing coffee. Therefore producers can produce a higher amount of coffee, and also can supply a higher quantity at a given price. Therefore the supply of coffee will increase which can be shown by the rightward shift of the supply of the coffee curve.

From figure 3, we can see that a decrease in the cost of labour used to farm coffee beans is represented by the rightward shift of the supply curve. At the new equilibrium B, the equilibrium price of coffee will decline from P0 to P1 and the equilibrium quantity of coffee will increase from, Q0 to Q1.( Refer to figure 3)

D. Any natural disaster such as a series of rainstorms reduces the supply of the good at a given market price. As here, in this case, a series of rainstorms cause a depletion of the coffee bean crop, the supply of coffee will decline at a given market price, therefore the supply curve will shift leftward.

From figure 4, we can see that due to a series of rainstorms, the supply curve shifts to the left. At the new equilibrium B, the equilibrium price of coffee increases from P0 to P1 and the equilibrium quantity of coffee will decline from Q0 to Q1. ( refer to figure 4)