Economics for Business
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The following information is available for three goods – Tea, Coffee and Sugar:
Income elasticity of demand for Tea: +0.2
Cross price elasticity of demand between Tea and Sugar: -0.8
Cross price elasticity of demand between Tea and Coffee: +1.2
Within a framework of demand and supply, graphically demonstrate the following situations and identify what happens to the equilibrium price and quantity of Tea:
- a) The price of Coffee increases. [2 marks]
Given that coffee and Tea are substitutes, and increase in price of coffee would lead to its decrease in demand and thus resulting to an increase in demand of tea. This implies that more tea will be consumed. An increase in the price of a substitute would have the opposite effect: the demand curve would shift right (Fleeming1870).
The first equilibrium (with the green supply and red demand) happens at the price of P1 and amount (purchased and sold) of Q1. As the demand bend moves (to the purple bend), the equilibrium price increases to P2 and the amount (purchased and sold) increases to Q2. Purchasers purchase a greater amount of the great, yet must pay a higher price to get it.
- b) There is a reduction in consumer income. [2 marks]
Given that Tea and coffees are substitutes (inferior goods), a decrease in consumer income would result to a decrease in demand. When demand decreases due to decrease in income, it will move the equilibrium, and thus decrease both the price and the quantity traded of the good (Arrigo 2009)
The first equilibrium (with the green supply and red demand) happens at the price of P1 and amount (purchased and sold) of Q1. As the demand bend moves (to the purple bend), the equilibrium price reductions to P2 and the amount (purchased and sold) declines to Q2. Purchasers purchase less of the great, and pay a lower price to get it.
- c) The Government imposes a per unit tax on Tea producers at the same time as a health scare identifies a risk associated with excessive Tea consumption. [3 marks]
If the government imposes a unit tax on tea and also a health scare is associated with tea consumption, given that coffee and tea are substitutes and holding all other factors constant, this would lead to more consumption of coffee (Goodwin, N 2009).
The demand of coffee would rise and the demand and supply of tea decreases. This would result to increased equilibrium price and quantity demanded. Due to new tax per unit, the cost or producing tea would rise thus resulting to decreased supply.
The first equilibrium (with the green supply and red demand) happens at the price of P1 and amount (purchased and sold) of Q1. As the supply bend moves (to the purple bend), the equilibrium price increases to P2 and the amount (purchased and sold) abatements to Q2. Supplies offer less of the great; however get paid a higher price to offer it.
- d) The price of Sugar increases at the same time as Tea producers adopt a more efficient production technology. [3 marks]
Sugar and tea are compliments. On the off chance that price of a reciprocal decent (say, sugar) increases, and then demand for given product (say, tea) will fall as it will be generally costlier to utilize both the merchandise together (Thomas M. Humphrey, 1992).
At the point when price of corresponding merchandise (say, sugar) rises, demand for the given ware (say, tea) tumbles from OQ to OQ1 at the same price of OP. Subsequently, the demand curve of the given goods shifts to the left from DD to D1D1.
- The demand for Milk is described by the following relationship between price (P, measured in £s) and quantity (Q, measured in thousands of litres):
P = 1200 –5Q
The supply of Milk is similarly represented by the following:
P = 120 + 3Q
A). Equilibrium Price and Quantity of milk
Equilibrium = Demand = Supply
Demand – P =1200 – 5Q
Supply – S = 120 + 3Q
1200 – 5Q = 120 + 3Q
-8Q = 120 – 1200
-8Q = -1080
Quantity of milk = 135 Litres
P = 120 + 3Q
P = 120 + 3Q
P = 120 + (135 × 3)
Price of milk = 535£
- B) (Old Demand) P = P 120 + 3Q
(New Demand) P = 120 + 3Q – 0.04
The new demand as a result of government subsidy shifts the demand curve to the left.
P = 119.96 + 3Q
119.96 + 3Q = 1200 – 5Q
8 Q = 1080
(New Equilibrium Quantity) Q = 135.005
P = 119.96 + (3×135.005)
(New Equilibrium Price) P = 524.975
C). Price elasticity of demand associated with price change
Price Elasticity in demand = % change in quantity demanded / % Change in price
Where Q = 13
Where p = 535
Arrigo Opocher and Ian Steedman, “Input Price-Input Quantity Relations and the Numeraire”, Cambridge Journal of Economics, V. 3 (2009): 937–948
Mankiw, N.G.; Taylor, M.P. (2011). Economics (2nd ed., revised ed.). Andover: Cengage Learning.
Fleeming Jenkin, 1870. “The Graphical Representation of the Laws of Supply and Demand, and their Application to Labour,” in Alexander Grant, ed., Recess Studies, ch. VI, pp. 151–85. Edinburgh: Edmonston and Douglas
Goodwin, N, Nelson, J; Ackerman, F & Weissskopf, T: Microeconomics in Context 2d ed. Sharpe 2009
Thomas M. Humphrey, 1992. “Marshallian Cross Diagrams and Their Uses before Alfred Marshall,” Economic Review, Mar/Apr, Federal Reserve Bank of Richmond, pp. 3–23