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Answer to Question #42917 in Microeconomics for Agi

Question #42917
In this section, we ask you to write down a simple, formal, mathematical model. A small
number of points will be awarded for an intuitive discussion of the problem, but most of
the points are reserved for a formal solution. Be careful to state all assumptions, and
remember above all to keep your answers simple and straight-forward!

Let's assume that coffee is addictive. However, before any individual person drinks
coffee for the first time, he/she does not know how addictive he/she will find coffee to be.
Please write down a formal model of addiction with uncertainty, and use the model to
(a) How do risk preferences influence coffee drinking?

(b) How does the price of coffee influence coffee drinking?
Expert's answer
1)In the coffee consumption group, no significant differences can be found in the reasons for consumption, the components of coffee, and its effects on health.

In the coffee non consumption group, significant gender differences can be noted in the reasons for avoiding coffee.

2) Supply and demand come together in the marketplace. Change in price for coffee influences demand for coffee similar to other products. With a downward-sloping demand curve and an upward-sloping supply curve, there will ordinarily be a point of intersection of the two curves. That point shows the price at which the quantity demanded in the market equals the quantity
supplied. This is called an equilibrium point, and the corresponding price is the equilibrium price while the corresponding quantity is the equilibrium quantity. At equilibrium, there is no tendency for price or quantity to change.

Consider now prices below the equilibrium price.The quantity demanded will be greater than the quantity supplied. This is
referred to as excess demand, or a shortage. In the face of a shortage, consumers will compete with one another for the limited supply, and this will result in an increase in the price of the product. The increase in price will stimulate a reduction in quantity demanded and an increase in quantity supplied (movements up along the demand curve and the supply curve) until the
equilibrium point is reached. Conversely, at prices above the equilibrium price, quantity demanded will be smaller than the quantity supplied, and there will be excess supply (a surplus) in the market. With a surplus, firms will compete to sell their products, and this will result in downward pressure on the price of the product. As with a shortage, there will be movements along the supply and demand curves as price changes, until the equilibrium point is reached.

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