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Chapter 16: Q4. (page 642)

Jennifer and Drew consume orange juice and coffee.Jennifer’s MRS of orange juice for coffee is 1 andDrew’s MRS of orange juice for coffee is 3. If the priceof orange juice is \(2 and the price of coffee is \)3, whichmarket is in excess demand? What do you expect tohappen to the prices of the two goods?

Short Answer

Expert verified

Given the marginal rate of substitution between orange juice and coffee as 1:1 for Jennifer and 3:1, we see both are willing to exchange coffee for orange juice. Therefore, the market of orange juice has an excess demand. The prices of orange juice will rise, and coffee will fall.

Step by step solution

01

Step 1. Excess demand

Jennifer is willing to exchange 1 coffee for 1 orange juice. At the same time, Drew is willing to exchange 3 coffees for 1 orange juice. Therefore, they both are willing to exchange 2/3 of coffee for 1 orange juice.

Hence it is established that both of them prefer orange juice over coffee, and therefore the demand for orange juice is in excess.

02

Step 2. Prices of both goods

Given the excess demand for orange juice, the prices of orange juice will rise due to a shortage of supply in the short run.

We know that demand for coffee will be less, and therefore there will be an excess supply of coffee, due to which the price of coffee will fall.

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Most popular questions from this chapter

Jane has 3 liters of soft drinks and 9 sandwiches. Bob, on the other hand, has 8 liters of soft drinks and 4 sandwiches. With these endowments, Jane’s marginal rate of substitution (MRS) of soft drinks for sandwiches is 4 and Bob’s MRS is equal to 2. Draw an Edgeworth box diagram to show whether this allocation of resources is efficient. If it is, explain why. If it is not, what exchanges will make both parties better off?

In the analysis of an exchange between two people, suppose both people have identical preferences. Will the contract curve be a straight line? Explain. Can you think of a counter example?

Using general equilibrium analysis, and taking into account feedback effects, analyze the following:

a. The likely effects of outbreaks of disease on chicken farms on the markets for chicken and pork.

b. The effects of increased taxes on airline tickets on travel to major tourist destinations such as Florida and California and on the hotel rooms in those destinations.

In the context of our analysis of the Edgeworth production box, suppose that a new invention changes a constant-returns-to-scale food production process into one that exhibits sharply increasing returns. How does this change affect the production contract curve?

Suppose gold (G) and silver (S) are substitutes for each other because both serve as hedges against inflation. Suppose also that the supplies of both are fixed in the short run (QG= 75 andQS= 300) and that the demandsfor gold and silver are given by the following

equations:

PG= 975 -QG+ 0.5PSandPS= 600 -QS+ 0.5PG.

a. What are the equilibrium prices of gold and silver?

b. What if a new discovery of gold doubles the quantity supplied to 150? How will this discovery affect the prices of both gold and silver?
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