Question

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

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

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.

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.