Question

Two types of coffee, Arabica and Robusta, are substitutes and both are grown and consumed in Vietnam. Following a government incentive program, the number of farms growing Arabica increases in Vietnam.

(a) What is the impact on the market for Arabica in Vietnam? Please explain, using a graph of demand and supply of Arabica, and please label the graph completely.

(b) What is the impact on the market for Robusta in Vietnam? Please explain, using a graph of demand and supply of Robusta, and please label the graph completely.

Answer 1

a)

Following a government incentive, the number of farms growing Arabica increases in Vietnam. As the number of farms growing Arabica will increase, the supply of Arabica will increase and the supply curve will shift to the right. At the original equilibrium price, an increase in supply would result in excess supply. As excess supply will emerge, a downward pressure is exerted on the price and the equilibrium price will fall. As quantity supplied of Arabica increases, the equilibrium quantity will increase.

In the above graph, the market is Initially in equilibrium at point E where demand D equals supply S. The equilibrium price is P and equilibrium quantity is Q. As the number of farms growing Arabica increases, the supply of Arabica will increase and supply curve will shift to the right to S1. The market is now in equilibrium at point A where original demand curve D and new supply curve S1 will intersect. From the above graph we can see that the Equilibrium price has reduced to P1 and equilibrium quantity has increased to Q1.

Hence, in the market for Arabica, the Equilibrium price will fall and equilibrium quantity will increase.

B)

As Arabica and Robusta are substitutes, a decrease in the price of Arabica( as seen in part (a)that equilibrium price of Arabica has reduced) will result in a decrease in the quantity demanded of Robusta as Robusta is now relatively costlier. At the original price, this decrease in the quantity demanded will result in excess supply in the market for Robusta. This excess supply would exert a downward pressure on the price and equilibrium price will fall. As quantity demanded has decreased, the equilibrium quantity of Robusta will fall.

In the above graph, the market Robusta is in equilibrium at point E where demand D equals supply S. Equilibrium price is P and equilibrium quantity is Q. As the price of Arabica will decrease, the quantity demanded of Robusta will decrease and demand curve will shift to the left to D1. The market is now in equilibrium at point M where original supply curve S and new demand curve D1 intersect. From the above graph we can see that the equilibrium price has decreased to P1 and equilibrium quantity has reduced to Q1.

Hence, in the market for Robusta, both equilibrium price and equilibrium quantity will decrease.