Economics Assignment: Impact of Coffee Price on Consumer Choices

This economics assignment analyzes the effects of a coffee price increase on the quantity demanded of coffee and pastries, using the indifference curve and budget line approach. The assignment assumes both goods are normal. It examines how the increase in coffee price impacts consumer choices, dividing the effect into income and substitution effects. The substitution effect shows the change in consumption due to altered relative prices, while the income effect reflects decreased purchasing power. The analysis utilizes a diagram to illustrate the shift in the consumer's equilibrium, demonstrating a decrease in coffee demand. The change in demand for pastries is also discussed, highlighting its dependence on the magnitude of purchasing power and the interplay of income and substitution effects. The paper concludes by summarizing the overall price effect and its impact on consumer behavior.

Running head: ECONOMICS ASSIGNMENT
Economics Assignment
Name of the Student
Name of the University
Author Note

1ECONOMICS ASSIGNMENT
Introduction
The indifference curve can be defined as the curve showing all the combinations of two
commodities, which give the same level of utility or satisfaction to the consumer, in a two-
commodity economy. The budget line, on the other hand, shows the consumer’s ability to buy
different combinations of two commodities. The equilibrium occurs at the point, where the
indifference curve of a consumer touches his budget line. In this essay, using this approach the
effects of a change in price of coffee, on the quantity demanded of coffee and pastries, by a
particular consumer, is tried to be analyzed, assuming that both the commodities are normal
goods (Rader, 2014).
Effects of increase in the price of coffee
In the given problem, it is assumed that the consumer spends his entire income on the
consumption of coffee and pastries, both of which are normal goods, which mean with the
increase in price the demand for these commodities decrease and vice versa. When there is a
considerable increase in the price of coffee, the effect of the increase in price on the quantity
demanded of both the goods can be divided into two parts, the income effect and the substitution
effect (Rios, McConnell & Brue, 2013).
The income effect shows the change in consumption of the consumer due to an increase
in the price of a commodity, which decreases the purchasing power of the consumer. On the
other hand the substitution effect shows the change in the consumption of the commodities that
happens due to the change in the relative prices of the two commodities following the hike in the
price of one commodity. In the concerned case, coffee being a normal commodity, with the

2ECONOMICS ASSIGNMENT
increase in the price of coffee, the relative price of coffee also increases and the overall
purchasing power of the consumer also decreases, the effects of which are shown as follows:
Figure 1: Effects of increase in the price of coffee
(Source: As created by the author)
As can be seen from the above diagram, the initial equilibrium of the consumer is at E0,
with the indifference curve Ic1 being tangent on the budget line AB0. With the considerable
increase in price of coffee, price of pastries remaining unchanged, the budget line rotates to AB1.
With the help of the compensated budget line (the dotted line), it can be seen that, assuming that

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the purchasing power of the consumer is kept at the initial level, with the increase in the price of
coffee, the demand for coffee declines from Qc to Qc’ (Hall & Lieberman, 2012). This is the
substitution effect, which is negative as coffee is a normal good. Now, given the original income
showing a lesser purchasing power, the equilibrium shifts to E2, with the new IC being Ic1 and
the quantity of coffee decreasing further to Qc’’. This is the negative income effect. Thus, the
entire price effect shows the decrease in demand for coffee from Qc to Qc’’. The change in the
demand for pastries, however, depends on the magnitude of the change in purchasing power and
the income and substitution effects. It may decrease, remain the same or may even increase to a
little extent if the demand for coffee is substantially decreased (Dixon et al., 2012).

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References
Dixon, P. B., Bowles, S., Kendrick, D., Taylor, L., & Roberts, M. (2012). Notes and problems in
microeconomic theory (Vol. 15). Elsevier.
Hall, R. E., & Lieberman, M. (2012). Microeconomics: Principles and applications. Cengage
Learning.
Rader, T. (2014). Theory of microeconomics. Academic Press.
Rios, M. C., McConnell, C. R., & Brue, S. L. (2013). Economics: Principles, problems, and
policies. McGraw-Hill.