AddToAny

Share

Supply & Demand Changes in Equilibrium

Changes in Supply & Demand Equilibrium



The equilibrium price and quantity can change only if demand or supply changes. In turn, demand or supply changes only when there is a change in one of the determinants of demand or supply.

Change in demand: The determinants of demand are: consumer income, consumer tastes, the prices of complements, the prices of substitutes, consumer expectations, and the number of potential buyers. Demand will change whenever one of these determinants of demand changes.

A decrease in demand: When demand decreases, it means that consumers are willing and able to purchase a lower quantity at each and every price. Looking at it another way, it means that it will take a lower price to induce consumers to purchase the same quantity. For any given supply, a decrease in demand means that the market price will decrease while the quantity sold will also decrease. This is represented on a demand / supply graph as: the demand curve shifts left (down); this new demand curve intersects the given supply curve at a point where the new equilibrium shows a lower price and a lower quantity than the old equilibrium.

[adsense:250x250:1859447701]

An increase in demand: When demand increases, it means that consumers are willing and able to purchase a higher quantity at each and every price. Looking at it another way, it means that consumers will pay a higher price for the same quantity. For any given supply, an increase in demand means that the market price will increase and the quantity sold will also increase. This is represented on a demand / supply graph as: the demand curve shifts right (up); this new demand curve intersects the given supply curve at a point where the new equilibrium shows a higher price and a higher quantity than the old equilibrium.

Change in supply: The determinants of supply are: the prices of resources, technology and productivity, expectations of producers, the number of suppliers, and the prices of alternative goods and services that the firm could produce. Supply will change when one of these determinants of supply changes.

A decrease in supply: When supply decreases, it means that suppliers are willing and able to supply a lower quantity at each and every possible price. Looking at it another way, it will take a higher price to induce producers to supply the same quantity. For any given demand, a decrease in supply means that the market price will increase while the quantity sold will decrease. This is represented on a demand / supply graph as: the supply curve shifts left (up); this new supply curve intersects the given demand curve at a point where the new equilibrium shows a higher price and a lower quantity than the old equilibrium.

An increase in supply: When supply increases, it means that suppliers are willing and able to supply a higher quantity at each and every possible price. Looking at it another way, suppliers will accept a lower price to supply the same quantity. For any given demand, an increase in supply means that the market price will decrease while the quantity sold will increase. This is represented on a demand / supply graph as: the supply curve shifts right (down); this new supply curve intersects the given demand curve at a point where the new equilibrium shows a lower price and a higher quantity than the old equilibrium.

A summary of the effects of changes in demand and supply on the equilibrium price and quantity:

The effects of multiple changes in demand and supply on the equilibrium price and quantity:

Often in economics class you will have exercises where you have to determine the effects on the equilibrium price and quantity when both the demand and supply change at the same time.

To solve these types of problems, you need to consider the cumulative effect of the multiple changes. For either price or quantity, if all changes are in the same direction, then the cumulative change will be in that direction. But if changes go in opposite directions, the cumulative changes will be unknown, or indeterminate. Changes in opposite direction are indeterminate unless you know which change is larger.

The following table summarizes the cumulative changes when both the demand and the supply change. These cumulative changes are determined by "adding together" the change in demand and the change in supply:

Equilibrium in the real world:

Economists use simplified models to study interrelationships. In general, they consider the relationship between two variables at a time; they consider the effects of a change in one of the variables on the other variable. In order to do this in the simplified model, they make the assumption of ceteris paribus. In other words, they assume that everything else remains constant so that they can focus on the specific relationship at hand. In the real world, everything else does not remain constant. Changes occur all the time in a dynamic economy. This means that equilibrium is seldom (if ever) reached. However, forces are always at work to move towards equilibrium. The models remain useful, and the studies are valid.

Price controls:

Price controls are limits set by the government on allowable prices for specific goods or services. An upper limit is called a price ceiling. A lower limit is called a price floor. If a price control prevents the equilibrium price from being reached, it is an effective price control.

Price ceiling: An effective price ceiling would be an upper price limit that is below equilibrium. At a price below equilibrium, consumers would demand a higher quantity than producers would supply; a shortage would result. The quantity demanded would be above the equilibrium quantity; the quantity supplied would be below the equilibrium quantity. The amount of the shortage would be the difference between the quantity demanded and the quantity supplied at the price ceiling level.

Price floor: An effective price floor would be a lower price limit that is above equilibrium. At a price above equilibrium, consumers would demand a lower quantity than producers would supply; a surplus would result. The quantity demanded would be below the equilibrium quantity; the quantity supplied would be above the equilibrium quantity. The amount of the surplus would be the difference between the quantity supplied and the quantity demanded at the price floor level.

Notice that with an effective price ceiling, the quantity supplied would be below the equilibrium quantity. The quantity supplied would be the quantity that is actually exchanged. Consumers cannot purchase what suppliers do not offer for sale. With an effective price floor, the quantity demanded would be below the equilibrium quantity. The quantity demanded would be the quantity that is actually exchanged. Producers cannot sell what consumers will not buy.

This means that price ceilings and price floors both lower the quantity exchanged in the marketplace.

Continue with a discussion of supply and demand in the factor markets