Question

The general demand and supply functions given below describe the market for coffee. Demand and Supply are both functions of coffee's own price, P. Supply is also a function of the price of an input, coffee beans, Pb.

Qd=D(P)

Qs=S(P,Pb)

a.) Use comparative statics to predict how the equilibrium price P*, changes when Pb increases. Start with the equilibrium condition, incorporating the fact that the equilibrium price, P*, is a function of Pb so that D(P*(Pb))=S(P*(Pb),Pb). Put a sign on dP*/dPb under the assumption that supply is decreasing in Pb.

b.) Explain why it is correct to write the equilibrium price as a function of Pb.

c.) Using results from part a) and the demand function, find an expression for the impact of an increase in Pb on equilibrium quantity. And, put a sign on dQ*/dPb.

Answer 1