Question

Coffee and tea are substitutes, and production of both goods is sensitive to climate change. Coffee production is negatively affected by drought in the major coffee-producing countries (especially Brazil and Vietnam). Tea production is negatively affected by extreme rainfall events in tea-producing countries (especially China and India).We observe that the equilibrium price of tea has risen and the equilibrium quantity of coffee has risen. What could be responsible for this pattern –a drought in Brazil, or an extreme rainfall season in India? Use two separate graphs, side-by-side, - one representing the market for coffee and the other market for tea to explain your answer.

Answer 1

The equilibrium price of tea can rise in two scenarios: increase in its demand or decrease in its supply. Since we have been given a supply shock in the form of extreme rainfall, let us suppose the rainfall negatively affects the supply of tea and the supply curve shifts leftward to S1. That is, less is supplied at each price level.

At the intersection of demand and new supply curve in the market for tea, the equilibrium price rises and equilibrium quantity falls.

Since tea and coffee are substitutes, a rise in price of tea will result in rise in demand for coffee since coffee is now relatively cheaper and people start substituting coffee for tea. As a result, the demand for coffee rises and the demand curve shifts rightward to D1.

At the intersection of new demand and supply curve in the market for coffee, the equilibrium price rises and equilibrium quantity also rises.

Thus the pattern: the equilibrium price of tea has risen and the equilibrium quantity of coffee has risen- is explained by extreme rainfall season in India.