Question

1. Brands have been made illegal. People value high quality soda at $2/can and low quality soda at $1/can. High quality soda costs $1.75/can to make, while low quality soda costs $0.75/can to make.  
   1. What is the efficient outcome?  
   2. Assuming that consumers are willing to pay for soda based on the average quality in the market and that there are as many high and low-quality sodas out there to start with, what is the equilibrium outcome in this market?  

3. What causes the demand curve for a Veblen good to have its unusual shape?

Answer 1

a) Economic efficiency is basically just a measure of how good things are economically, compared to how good they could potentially be. The formula for determining economic efficiency is as follows:

Economic efficiency = f(Actual value of variable/Potential value of variable)

Market efficiency refers to the degree to which market prices reflect all available, relevant information. If markets are efficient, then all information is already incorporated into prices, and so there is no way to "beat" the market because there are no undervalued or overvalued securities available. As the quality and amount of information increases, the market becomes more efficient reducing opportunities for arbitrage and above market returns.

b) The equilibrium price is the only price where the desires of consumers and the desires of producers agree—that is, where the amount of the product that consumers want to buy (quantity demanded) is equal to the amount producers want to sell (quantity supplied).

• Suppose that the demand for soda is given by the following equation: Qd=16–2P

where Qd is the amount of soda that consumers want to buy (i.e., quantity demanded), and P is the price of soda.

• Suppose the supply of soda is   Qs=2+5PQs=2+5P

where Qs is the amount of t that producers will supply (i.e., quantity supplied).

• Finally, suppose that the soda market operates at a point where supply equals demand, or   Qd=Qs

• we can set the demand and supply equation equal to each other:

  ​Qd=Qs​ 16−2P=2+5P

• 16−2P=2+5P​

• −2+2P=−2+2P​

• 14=7P​​

• 2=P

• The price of each soda will be $2.

3. A veblen good is a good for which demand increases as the price increases, because of its exclusive nature and appeal as a status symbol. A Veblen good has an upward-sloping demand curve, which runs counter to the typical downward-sloping curve. However, a Veblen good is generally a high-quality, coveted product, in contrast to a Giffen good, which is an inferior product that does not have easily available substitutes.Although the theory of conspicuous consumption as developed by Veblen and others is quite a complex and subtle sociological construct we can, for our purposes, quite legitimately abstract from the psychological and sociological elements and address our attention exclusively to the effects that conspicuous consumption has on the demand function. The essential economic characteristic with which we are concerned is the fact that the utility derived from a unit of a commodity employed for purposes of conspicuous consumption depends not only on the inherent qualities of that unit, but also on the price paid for it. It may, therefore, be helpful to divide the price of a commodity into two categories; the real price and the conspicuous price. By the real price we refer to the price the consumer paid for the commodity in terms of money. The conspicuous price is the price other people think the consumer paid for the commodity' and which therefore determines its conspicuous consumption utility. These two prices would probably be identical in highly organized markets where price information is common knowledge. In other markets, where some can get "bargains" or special discounts the real price or conspicuous price need not be identical. In any case, the quantity demanded by a consumer will be a function of both the real price and the conspicuous price.