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5. Changes in Supply and Demand
Essay:
1. Describe the process by which a change in supply or demand leads to a
change in the equilibrium price and quantity. Illustrate with a diagram.
2. Describe the effects on the equilibrium price and quantity of a change in
supply and demand.
Given a specific scenario, describe what change is
certain and what change is ambiguous.
Explain why.
Changes in Equilibrium Price and Quantity
Relative prices are constantly changing because of changes in supply and
demand. There are four basic possibilities.
Increase in Demand
An increase in demand implies that buyers want to buy more of the good
at the initial price. (This is illustrated by shifting the demand curve to
the right.) The immediate result is a shortage. Sellers raise their prices.
The higher price leads to an increase in the quantity supplied and a decrease
in the quantity demanded. At the new equilibrium price, quantity supplied and
quantity demanded are again equal. But the new equilibrium price and the new
equilibrium quantity are higher.
P- Price
Q-Quantity
P
S
P2
P1
D2
D1
Q1 Q2 Q
Decrease in Demand
A decrease in demand has the opposite effect of an increase. Buyers want
to buy less of the good at the initial price. (This is illustrated by
shifting the demand curve to the left.) The immediate result is a surplus.
Sellers shave their prices to raise sales. The lower price leads to an
increase in the quantity demanded and a decrease in the quanitity supplied.
At the new equilibrium price, quantity supplied and quantity demanded are
again equal. But the new equilibrium price and the new equilibrium quantity
are lower.
P
S
P1
P2
D1
P- Price
D2
Q-Quantity
Q2 Q1
2
Increase in Supply
An increase in supply implies that sellers want to sell more at the
initial price. (This is illustrated by shifting the supply curve to the
right.) The immediate result is a surplus. Sellers lower their prices to
sell the extra product. The lower price leads to a decrease in the quantity
supplied and an increase in the quantity demanded. At the new equilibrium
price, quantity supplied and quantity demanded are again equal. But the new
equilibrium price is lower and the new equilibrium quantity is higher.
P
S1
S2
P1
P2
P- Price
Q-Quantity
D
Q1 Q2
Q
Decrease in Supply
A decrease in supply has the opposite effect of an increase. Sellers want
to sell less at the initial price. (This is illustrated by shifting the
supply curve to the left.) The immediate result is a shortage. Sellers raise
their prices to make more money. The higher price leads to an increase in the
quantity supplied and a decrease in the quantity demanded. At the new
equilibrium price, quantity supplied and quantity demanded are again equal.
But the new equilibrium price is higher and the new equilibrium quantity is
lower.
P
S2
S1
P- Price
Q-Quantity
P2
P1
D
Q2 Q1
Changes in Supply and Demand
When both supply and demand change at the same time, the effects on either
price or quantity can be discovered, but not both.
The effects on one or the
other is ambiguous.
For example, if both demand and supply increase, the equilibrium
quantity clearly increases because both an increase in demand and an increase
in supply cause quantity to rise.
On the other hand, the effect on the
equilibrium price is ambiguous.
That means it could either increase or
decrease depending on whether the increase in supply or the increase in demand
is greater. If demand rises more than supply, then price will rise. If
supply rises more than demand, then price will fall.
If supply and demand
increased the exact same amount, then price remains the same.
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P
S1
S2
P2
P1
D2
D1
Q1
Q2
Q
In the diagram above, the quantity increases and the effects on the price
is ambiguous.
This particular diagram shows demand increasing more than
supply, so the price increases.
If supply decreases and demand decreases, then the result is the opposite.
The quantity decreases and impact on the price is ambiguous.
On the other hand, what if supply decreases and demand increases. In
that situation, the equilibrium price increases, but the effects on the
quantity is ambiguous. That’s because both an increase in demand and a
decrease in supply raise the equilibrium price. But since an increase in
demand increases quantity and a decrease in supply decreases quantity, the two
tend to counteract one another.
That leaves the net effect ambiguous. If
the decrease in supply is greater than the increase in demand, then quantity
decreases. If the increase in demand is greater than the decrease in supply,
then quantity increases. And if the change in supply and demand are exactly
the same, quantity isn’t effected.
S2
P
S1
P2
P1
D2
D1
Q1 Q2
Q
The diagram above shows an increase in demand and a decrease in supply.
The price clearly increases, but the quantity is ambiguous. In this example,
the quantity increases because demand increased more than supply decreased.
Discussion: When people decide they really like a product, they
demand more of it. That causes an increase in price. A higher
price goes with higher demand, so the law of demand is false.
Comment.