Currently the tea market is in equilibrium at price $4.00 per bag of tea and 100,000...

Currently the tea market is in equilibrium at price $4.00 per bag of tea and 100,000 bags of tea. Now, suppose the price of coffee decreases by 10%. This will lead to a 25% change in the equilibrium price of tea. The Price Elasticity of Demand (Ed) for Tea has been calculated to be 1.20 and the Price Elasticity of Supply for Tea has been calculated to be 0.90. Answer the following questions based on these events and facts.

(a) Will the Supply of Tea increase, decrease or stay the same? Please explain the reasoning for your answer?

(b) Will the Demand for Tea increase, decrease or stay the same? Please explain the reasoning for your answer.

(c) Determine the new Equilibrium Price of Tea. Show how you got your answer.

(d) Using the Definition Formula for the Price Elasticity of Demand (Ed) and/or the Definition Formula for the Price Elasticity of Supply (s) determine the new Equilibrium Quantity of Tea. Please clearly show your work.

Expert Solution

a) The supply will have no direct effect, niether it will decrease or increase ,as the supply determinants of a good are cost of production , number of suppliers , state of technology, government subsidies ,weather condition and availability of workers .... In these the price of substitute goods play no role thereafter with rise or fall in price of substitute good the supply of other will have no effect

b) However,unlike the supply the demand will definately get effected . Coffee being a substitute good for tea is now available at cheaper rate this will decrease the demand for tea and increase the demand for coffee. As fall in price of substitute good rise it's demand and decrease demand of the other good

c) As per question ,with fall in price of coffee the equilibrium price of tea has fallen by 25% i.e (old price multiply by change percent ; then old price minus percent change price = new price) old price = 4 × 25% = 1 ,then $4- $1 = $3 which is new equilibrium price of tea.(shown in pic uploaded)

d) as per price elasticity of demand = change in quantity demand ÷ percent change in price of good ( as done in pic uploaded)

Kindly please rate the answer and do feel free to ask doubts

Rahul Sunny answered 2 years ago

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