A. Describe the initial market where income is $1000/mth. Include the equilibriu

Question

A. Describe the initial market where income is $1000/mth. Include the equilibrium and price-elasticities of supply and demand. Briefly discuss how your answer is affected by rounding and price point selection for your calculations.

B. Describe the welfare of buyers and sellers in this market where income is $1000/mth. Include mathematical support in your answer.

C. Identify the type of good Bread is in this market. Include mathematical support to defend your answer.

D. Identify the relationship of Bread and Bagels as related goods. Include mathematical support to defend your answer.

E. If the price of Bread increased, what change, if any, would be expected in the Bagel market?

Bonus: Create a fully labelled graph of the supply and demand for Bread with welfare areas shaded and labeled at the income level of $1000/mth. You may include this in part B above to support your comments and calculations.

Income= $1000/mth Income=$1250/mth |Income=$1250/mth Price of Quantity Supplied Quantity Demanded Quantity Demanded Quantity Demanded of Bread 6 of Bread of Bread 6 3 2 Bread of Bagels 1.00 $ 2.00 $200 $ 3.00 $ 3.00 4.00 $ 5.00 6 10

Explanation / Answer

(A)

The initial market exhibits the law of demand operative for breads where higher price lowers the quantity demanded of bread. Supply increases with price, as per law of supply.

Equilibrium is when demand equals supply. From the given data we cannot infer the exact equilibrium point.

Let's compute price elasticities at P = $2

(i) Elasticity of demand = Change in demand / Change in price

= [(2 - 3) / 3] / [(2 - 1) / 1]

= - (1/3) / 1 = - 1 / 3

(ii) Elasticity of supply = Change in supply / Change in price

= [(4 - 2) / 2] / [(2 - 1) / 1]

= 1 / 1 = 1

However, these elasticities are computed at only one price point (P = $2). If we measure elasticities at other prices, they will be different.

Finally, as we round off the numbers less & less, the elasticity values will be more & more precise & accurate.

(B)

The maximum price buyers are willing to ay at which they buy at least 1 unit is $3 & the minimum price at which sellers are willing to supply at least 1 unit is $1. Exact equilibrium point couldn't be determined but it lies in-between.

Buyers' welfare is determined by the gap between their maximum price & the actual price they pay (known as consumer surplus) and sellers' welfare is determined by the gap between the minimum price & actual price they receive (known as producer surplus).

Mathematically,

CS = (1/2) x (Max Price - Equilibrium price) x Equilibrium output = (1/2) x $(3 - Equilibrium price) x Equilibrium output

PS = (1/2) x (Equilibrium price - Min price) x Equilibrium output = (1/2) x $(Equilibrium price - 1) x Equilibrium output

(C)

Bread is a normal good which is revealed by the fact that with increase in consumer income, demand for bread increases at every price.

Mathematically, Income elasticity of demand = Change in demand / Change in income

When P = $2, Income elasticity = [(3 - 2) / 2] / [(1250 - 1000) / 1000]

= (1/2) / 0.25 = 0.5 / 0.25 = 2

Since income elasticity > 1, bread is a normal good.

(D)

As price of bread increases, quantity demanded of bagels increases, so bread & bagels are substitutes.

Cross price elasticity at P = $2 is = Change in quantity of bagel / Change in price of bread

= [(3 - 2) / 2] / [(2 - 1) / 1]

= (1/2) / 1 = 0.5

Since cross price elasticity > 0, bread & bagels are substitutes.

NOTE: First 4 sub-questions are answered in full.

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