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A Summary of how Demand and Supply Changes Affect Prices and Quantities The following summarizes the important relationships between changes in demand and supply and their corresponding equilibrium prices and equilibrium quantities changes. These are changes that take place in the short-term (usually within several months). In the long run (one year or longer), most products (especially manufactured goods subject to a fair amount of competition) will experience further price and quantity changes. Long run price changes are discussed in more detail in a later section in this unit. When we refer to “equilibrium price” it represents the price or market price, meaning the price that the grocery store, department store, gas station, etc. charges in a free market. When we mention “equilibrium quantity”, it represents quantity or the amount of a certain product bought and sold in a store or where ever goods and services are sold. When Demand Increases ==> Price Increases and Quantity Increases A Simultaneous Increase in Demand and Supply So we know that an increase in demand increases equilibrium price and quantity (and vice versa), and an increase in supply decreases equilibrium price and increases quantity (and vice versa). What happens if both demand and supply change at the same time? Let’s analyze the following examples. Example 1 Problem: Suppose that consumers’ incomes have gone up, and that an advance in technology has lowered the cost of making computers. Assuming that a computer is a normal good, what will happen to the equilibrium price and quantity of computers as a result of these two simultaneous changes? Solution: An increase in consumers’ incomes increases the demand for computers. This increases the equilibrium price and equilibrium quantity. An advance in technology increases the supply. This decreases the equilibrium price and increases the equilibrium quantity. Combining these two effects, the equilibrium quantity increases because the equilibrium quantity increases in both instances. The equilibrium price increased and then decreased, so on balance, it will either increase, decrease, or stay the same, depending on the size of the shifts in the curves. If demand increases more than supply, then the price increases, and vice versa. If we don’t know the magnitude of the shifts, we say that the price is indeterminate. In summary: Consumer Incomes ↑ ⇒Demand ↑ ⇒ Price ↑ and Quantity ↑ Advance in Technology ⇒ Supply ↑ ⇒ Price ↓ and Quantity ↑ ————————————————————————- Combined Effect = Price change unknown (indeterminate) and Quantity increases Example 2 Solution: Current demand for jewelry increases because buyers expect the price to increase in the future. This increases the equilibrium price and the equilibrium quantity. Supply of jewelry decreases because the increased tax makes it less attractive for firms to supply the product. This increases the price of jewelry and decreases the quantity bought/sold. The combined effect is that the price of jewelry increases, and the equilibrium quantity change is indeterminate. Note that when both demand and supply shift, one variable (price or quantity) experiences a definite change, and the other is indeterminate (unless you know the magnitude of the shifts). When only one curve shifts, both equilibrium price and quantity experience a definite change. In summary: Expected Future Price ↑ ⇒ Demand ↑ ⇒ Price ↑ and Quantity ↑ Production tax ↑ ⇒ Supply ↓ ⇒ Price ↑ and Quantity ↓ ————————————————————————- Combined Effect = Price increases and Quantity change unknown (indeterminate) Video Explanations The labor market is a special case of supply and demand. The demand for labor is the businesses’ willingness and ability to hire workers. The supply of labor is the workers’ willingness and ability to work at certain wage rates. For a labor market application of supply and demand changes and their effects on the equilibrium price of labor (the wage rate) and the equilibrium quantity (the number of workers hired), watch:
If you're seeing this message, it means we're having trouble loading external resources on our website. If you're behind a web filter, please make sure that the domains *.kastatic.org and *.kasandbox.org are unblocked. Demand and Supply models are very easy to use, when there is a change in either demand or supply. However, in reality, there are number of situations which lead to simultaneous changes in both demand and supply. (I) Both Demand and Supply decrease (II) Both Demand and Supply increase (III) Demand decreases and Supply increases (IV) Demand increases and Supply decreases Let’s relate this to ridesharing businesses — Uber, Lyft, Ola — where the simultaneous shifts are seen in action. In the case of ridesharing businesses, the demand is the number of riders (Q) and the supply is the number of drivers (S). (I) Both Demand and Supply Decrease:Original Equilibrium is determined at point E, when the original demand curve DD and the original supply curve SS intersect each other. OQ is the equilibrium quantity and OP is the equilibrium price. The effect of decrease in both demand and supply on equilibrium price and equilibrium quantity can be better analyzed under three different cases: Case 1: Decrease in Demand = Decrease in Supply:When decrease in demand is proportionately equal to decrease in supply, then leftward shift in demand curve from D to D¹ is proportionately equal to leftward shift in supply curve from SS to S¹S¹ . The new equilibrium is determined at E¹ As demand and supply decrease in the same proportion, equilibrium price remains same at OP, but equilibrium quantity falls from OQ to OQ¹. Impact: No change in Price for Riders. No change in Earnings for Drivers Case 2: Decrease in Demand > Decrease in Supply:When decrease in demand is proportionately more than decrease in supply, then leftward shift in demand curve from D to D¹ is proportionately more than leftward shift in supply curve from S to S¹. The new equilibrium is determined at E¹, equilibrium price falls from OP to OP¹ and equilibrium quantity falls from OQ to OQ¹. Impact: Drop in Price for Riders. Drop Earnings for Drivers Case 3: Decrease in Demand < Decrease in Supply:When decrease in demand is proportionately less than decrease in supply, then leftward shift in demand curve from D to D¹ is proportionately less than leftward shift in supply curve from S to S¹. The new equilibrium is determined at E¹ equilibrium price rises from OP to OP¹ whereas, equilibrium quantity falls from OQ to OQ¹. Impact: Increase in Price for Riders. Increase in Earnings for Drivers (II) Both Demand and Supply Increase:Original Equilibrium is determined at point E, when the original demand curve DD and the original supply curve SS intersect each other. OQ is the equilibrium quantity and OP is the equilibrium price. The effect of increase in both demand and supply on equilibrium price and equilibrium quantity is discussed under three different cases: Case 1: Increase in Demand = Increase in Supply:When increase in demand is proportionately equal to increase in supply, then rightward shift in demand curve from D to D1 is proportionately equal to rightward shift in supply curve from S to S¹. The new equilibrium is determined at E¹. As both demand and supply increase in the same proportion, equilibrium price remains the same at OP, but equilibrium quantity rises from OQ to OQ¹. Impact: No change in Price for Riders. No change in Earnings for Drivers Case 2: Increase in Demand > Increase in Supply:When increase in demand is proportionately more than increase in supply then rightward shift in demand curve from D to D¹ is proportionately more than rightward shift in supply curve from SS to S1S1. The new equilibrium is determined at E1equilibrium price rises from OP to OP¹ and equilibrium quantity rises from OQ to OQ¹. Impact: Increase in Price for Riders. Increase in Earnings for Drivers Case 3: Increase in Demand < Increase in Supply:When increase in demand is proportionately less than increase in supply, then rightward shift in demand curve from D to D¹ is proportionately less than rightward shift in supply curve from S to S¹. The new equilibrium is determined at E¹ equilibrium price falls from OP to OP¹ whereas, equilibrium quantity rises from OQ to OQ¹. Impact: Decrease in Price for Riders. Decrease in Earnings for Drivers (III) Demand decreases and Supply increases:The effect of simultaneous decrease in demand and increase in supply on equilibrium price and equilibrium quantity is analyzed in the following three cases: Case 1: Decrease in Demand = Increase in Supply:Impact: Decrease in Price for Riders. Decrease in Earnings for Drivers Case 2: Decrease in Demand > Increase in Supply:Impact: Greater decrease in Price for Riders. Greater decrease in Earnings for Drivers (IV) Demand increases and Supply decreases:The effect of increase in demand and decrease in supply on equilibrium price and equilibrium quantity is discussed in the following three cases: Case 1: Increase in demand = Decrease in supply:Impact: Increase in Price for Riders. Increase in Earnings for Drivers Case 2: Increase in Demand > Decrease in Supply:Impact: Greater increase in Price for Riders. Greater increase in Earnings for Drivers Case 3: Increase in Demand < Decrease in Supply:Impact: Increase in Price for Riders. Increase in Earnings for Drivers In this article, we just looked at the different possibilities of changes in supply and demand, and the impact on the pricing and earnings. In the next article, we look at levers such as surge pricing and incentives, which act as levers to adjust both supply and demand. |