Economics mod 2 case: Demand supply and elasticity
Module 2 - Background
SUPPLY AND DEMAND: MARKETS, PRICES AND PRICE SETTING
In this module, you are required to learn the basic theories of supply and demand. Supply and demand are the forces that make the market function. You will also study the concept of Elasticity. Elasticity is the measure of responsiveness of one variable from a change in another variable. In this course, we focus on the price elasticiy of demand. It is ratio of the percentage change in quantity demanded to the percentage change in a price of good. Essentially, it measures how consumers respond to changes in price. Please read the following materials (be sure to read the required sections):
Required Reading
Rittenberg L. and T. Tregarthen (2009). Chapter 3: Demand and Supply. Principles of Microeconomics. Retrieved from: http://www(dot)web-books(dot)com/eLibrary/NC/B0/B63/TOC.html
Rittenberg L. and T. Tregarthen (2009). Chapter 5: Elasticity and A Measure of Response Sections 1 and 2. Principles of Microeconomics. Retrieved from: http://www(dot)web-books(dot)com/eLibrary/NC/B0/B63/TOC.html
Course Handouts
Supply and Demand
Supply and Demand Issues
Optional Reading
Exercises of Elasticity—Interactive Questions and Answers. Retrieved February 18, 2011 from: http://hspm(dot)sph(dot)sc(dot)edu/COURSES/ECON/Elast/Elast.html
Investopedia, Economic Basics: Supply and Demand: Retrieved February 18, 2011 from:http://www(dot)investopedia(dot)com/university/economics/economics3.asp
Roberts, Russell. (2007). "Where do Prices Come from?" Library of Economics and Liberty. Retrieved February 18, 2011 from:http://www(dot)econlib(dot)org/library/Columns/y2007/Robertsprices.html
Schenk, Richard. (2009). The Model of Supply and Demand. CyberEconomics. Retrieved February 18, 2011 from: http://ingrimayne(dot)com/econ/DemandSupply/OverviewSD.html
Note: All readings were validated on March 17, 2013.
Module 2 - Case
SUPPLY AND DEMAND: MARKETS, PRICES AND PRICE SETTING
Case Assignment
Write a 3-page essay that addresses the following FOUR questions on the market for coffee. (For this case, keep it simple; don't worry about different brands, whether it is store-bought or prepared at home, etc.)
- Explain what happens to price and quantity of coffee when the following events occur (you do not need to analyze the event itself but rather focus on the effect on supply and demand of coffee):
- A scientific study shows that coffee helps reduce weight gain.
- Coffee plants from major producing countries are affected by drought. (Fun fact: a coffee bean is a misnomer for the seed of a coffee plant.)
- The price of tea decreases.
- In order to protect growers that have better working conditions for workers (referred to as Fair Trade), a price floor on coffee is implemented.
- Suppose Mr. Washington drinks 3 cups of coffee every day no matter what the price. What kind of elasticity does it have?
- Suppose that when the price of coffee increases by 40%, the percentage change in quantity demanded by consumer is reduced by 10%. Calculate the elasticity.
- Based on your answer to Question 3, What happens to total revenue when the price of coffee is increased. Why?
Some helpful suggestions on completing the assignment:
For each event, you must specify how it effects either demand, quantity demanded, supply, or quantity supplied. It is also important to demonstrate how the change will affect the market demand or supply curve. Also, be sure to state any assumption you are making regarding the relationship of the event and coffee.
Here is an example of the best way to answer question #1 above:
Event: Price of donut decreases.
Assume that donuts are a complement for coffee. If donuts are cheaper, then the consumer will increase quantity demanded of donuts. If consumers buy more donuts, then there will be a increased demand for coffee because it is its complement. This event causes a shift of the demand curve to the right. The shift will cause price and quantity of coffee to increase.
Here is also some helpful information on how to address the elasticity questions:
Inelastic goods (goods in which consumers are less responsive to changes in price): e < |-1|
Elastic goods (goods in which consumers are more responsive to changes in price): e > |-1|
In this course, we use the absolute value of elasticity. The price elasticity of demand is always calculated as a negative value due to the law of demand (inverse relationship between price and quantity).
Assignment Expectations
Use concepts from the modular background readings as well as any good-quality resources you can find. Be sure to cite all sources within the text and provide a reference list at the end of the paper.
Length: 3 pages double-spaced and typed.
The following items will be assessed in particular:
Answer the following questions after your essay is complete this can go under the references page.
The recent recession has hurt several industries due to a decline in demand by households. Think of the relationship between income and demand and discuss the following questions:
- What are "normal" goods? Define and give an example in our current economy.
- What are "inferior" goods? Define and give an example in our current economy.
- Do you think luxury goods are have more elastic or inelastic demand? Explain.
- Your ability to understand an application of supply and demand.
- Some in-text references to the modular background material (APA formatting not required).
- The essay should address each element of the assignment. Remember to support your answers with solid references including the case readings.
Name
Course
Instructor
Date
Explain what happens to price and quantity of coffee when the following events occur (you do not need to analyze the event itself but rather focus on the effect on supply and demand of coffee
A scientific study shows that coffee helps reduce weight gain.
Assume that there are changes in consumer preferences. In such an event that coffee is said to have positive effect on people there will be increased demand for coffee because of changing preferences. Preference for a good is related to satisfaction that consumers have from purchase of that good (Boyes& Melvin, 2012). Thus, benefit of reducing weight gain increases the satisfaction received from purchase and consumption of coffee. The power of preferences includes tastes and attitudes that people have about certain products, and advertising is typically used to influence consumer preferences (Tucker, 2012). Essentially, the purported benefit of reducing weight gain influences preference for coffee and this in turn shifts the demand. The demand curve will then shift to the right. Over time the price and quantity of coffee will increase.
Coffee plants from major producing countries are affected by drought. (Fun fact: a coffee bean is a misnomer for the seed of a coffee plant
Assume that there are fewer coffee suppliers. If weather conditions affect the supply of coffee, then the supply of coffee available will be less. This is because there is a reduction in the production of coffee, there are fewer sellers, and this in turn results to reduced supply in coffee. If the demand for coffee remains the same, then there is a new equilibrium price corresponding to the new quantity of coffee supplied. Essentially, the price of coffee supplied adjusts in line with the quantity supplied, while natural events like drought affect agricultural production and supply of agricultural goods (Rittenberg & Tregarthen, 2009). The decrease in supply will in turn result to a leftward shift of the supply curve, there is a rise in price of coffee but there is reduction in quantity supplied.
The price of tea decreases
Assume that tea is a substitute for coffee as it is related to coffee. If the price of tea is lower than that of coffee then more people will be willing to buy tea. Consumers take into account the price substitute goods as the goods serve the same purpose, and choose one in place of the other (McEachern, 2012). Additionally, consumers are willing to buy more quantity of low priced goods when placed with choosing goods that have the same utility like substitutes. Substitute goods are demand shifters and tea price reduction will result to a decrease in demand for coffee as tea is a substitute product. As there is less coffee consumed the demand curve shifts to the left resulting to a fall in the price and quantity of coffee demand.
In order to protect growers that have better working conditions for
workers (referred to as Fair Trade), a price floor on coffee is implemented
Assume that the price floor results to a surplus. The price control is set above the equilibrium price, and while the price is higher than the equilibrium price the quantity supplied is more than the quantity demanded. Thus, the price of both quantity supplied and demanded is the same. To return to the equilibrium price, the demand curve shifts right while the supply curve shifts leftwards. As an agricultural product, the equilibrium quantity of coffee is expected to rise dramatically as the equilibrium price falls, and this is because there is generally an increase in demand of agricultural products (Rittenberg & Tregarthen, 2009). The demand cur...