Question

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

Now, suppose a new method of picking tea leaves reduces the labor cost of picking tea leaves by 30%.

This new method will lead to a 20% change in the equilibrium price of tea.

The Price Elasticity of Demand (Ed) for Tea has been calculated to be 1.10.

The Price Elasticity of Supply (Es) for Tea has been calculated to be 1.40.

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) as presented in the Chapter 5 lectures and slides and/or the Definition Formula for the Price Elasticity of Supply (Es) as presented in the Chapter 5 lectures and slides determine the new Equilibrium Quantity of Tea. Please clearly show your work.

Answer 1

As labor cost decreases, producer is likely to raise their supply of tea leaves which will reduce its price by 20%

a) Elasticity of supply = 1.40

Elasticity of supply = %change in quantity supplied / %change in price

%change in quantity supplied = 1.40 * (-20%) = -0.28

%change in quantity supplied = -28%

Quantity supplied decreased by 28%

b) Elasticicty of demand = -1.1

Elasticity of demand = %change in quantity demanded / %change in price

%change in quantity demanded = -1.10 * (-20%) = 0.28

%change in quantity demanded = 22%

Quantity demanded increased by 22%

c) New equilibrium price = 4 - 4 * 0.2 = 3.2

d) Change in quantity supplied surpasses change in quantity demanded by 6% which result decrease in equilibrium quantity by 6%. Thus, new equilibrium quantity 100,000 - 6% * 100,000 = 94,000