Question 3
We study the market for coffee. Suppose that the supply of coffee is perfectly elastic at a price of $3.
Currently, 100 cups of coffee are bought and sold in this market every day.
(a) We are not sure if coffee is treated as a luxury or a necessity in this market. Draw the following supply
and demand diagram:
Supply Curve S
Demand Curve D_(N) : Demand for coffee if consumers treat it as a necessity
Demand Curve D_(L) : Demand for coffee if consumers treat it as a harury
Both demand curves should be consistent with the free-market equilibrium described above.
In an attempt to reduce the consumption of coffee, the government places restrictions on the sale of coffee.
This means that the supply of coffee is now perfectly elastic at 84 , because suppliers have to spend an extra
dollar to comply/evade the restrictions.
(b) Using your diagram, explain whether this restriction would be more or less effective if coffee is a highly
addictive substance.
Consider a completely different market - the market for corn. The demand for corn oil is perfectly inelastic:
this is an extreme case. The supply of corn oil is neither perfectly inelastic nor perfectly elastic.
(d) On a supply and demand diagram, show the impact of a tax on corn oil producers. Your diagram
should contain:
Supply Curve S
Demand Curve D
Tax-adjusted Supply Curve S^(T)
Free-market equilibrium quantity Q^(**)
Equilibrium quantity with a taxQ^(T)
Prices paid by consumers and producers when there is a tax, P^(D) and P^(S) respectively
(e) What is the tax incidence on consumers in this market?
Question 3 We study the market for coffee. Suppose that the supply of coffee is perfectly elastic at a price of S3. Currently, 100 cups of coffee are bought and sold in this market every day.
(a) We are not sure if coffee is treated as a luxury or a necessity in this market. Draw the following supply and demand diagram: Supply Curve S
Demand Curve D: Demand for coffee if consumers treat it as a necessity Demand Curve D: Demand for coffee if consumers treat it as a lurury
Both demand curves should be consistent with the free-market equilibrium described above.
In an attempt to reduce the consumption of coffee, the government places restrictions on the sale of coffee. This means that the supply of coffee is now perfectly elastic at $4, because suppliers have to spend an extra dollar to comply/evade the restrictions.
(b) Using your diagram, explain whether this restriction would be more or less effective if coffee is a highly addictive substance.
Consider a completely different market - the market for corn. The demand for corn oil is perfectly inelastic: this is an extreme case. The supply of corn oil is neither perfectly inelastic nor perfectly elastic.
(d) On a supply and demand diagram, show the impact of a tax on corn oil producers. Your diagram should contain: Supply Curve S Demand Curve D Tax-adjusted Supply Curve S7 Free-market equilibrium quantity Q Equilibrium quantity with a tax Q7 Prices paid by consumers and producers when there is a tax, p and ps respectively (e) What is the tax incidence on consumers in this market?
