How shifts in demand and supply change the equilibrium

Overview

What happens to price and quantity when demand shifts, when supply shifts, and when both move at once.

What you need to know

Answer each one before you reveal it.

Questions from this subtopic

Each one with the model answer underneath.

1. 1

   A rise in consumer incomes increases demand for a normal good. Describe precisely the effect on the equilibrium, naming the axes and the curve that shifts.

   Model answer

   With price on the vertical axis and quantity per period on the horizontal axis, the demand curve shifts to the right from D1 to D2 while the supply curve S is unchanged. At the original price there is now excess demand, so the price is bid up. As it rises, producers move up along the unchanged supply curve. The new equilibrium is where D2 cuts S, at a higher price P2 and a higher quantity Q2. Both equilibrium price and quantity rise.

2. 2

   A fall in demand for a good occurs because a substitute becomes cheaper. Describe the effect on the equilibrium.

   Model answer

   The demand curve shifts to the left from D1 to D2, with supply unchanged. At the original price the quantity supplied now exceeds the quantity demanded, so stocks build up and the price is cut. As price falls, producers contract output by moving down along the unchanged supply curve. The new equilibrium is at a lower price and a lower quantity, and producers' total revenue falls.

3. 3

   A rise in production costs reduces supply. Describe the effect on the equilibrium price and quantity.

   Model answer

   The supply curve shifts to the left, or equivalently upwards, from S1 to S2, with demand unchanged. At the original price there is excess demand because less is now offered, so the price rises. As it rises, consumers move up along the unchanged demand curve and reduce the quantity they buy. The new equilibrium has a higher price and a lower quantity.

4. 4

   A technological improvement increases supply. Describe the effect on the equilibrium price and quantity.

   Model answer

   The supply curve shifts to the right, or equivalently downwards, from S1 to S2, with demand unchanged. At the original price the quantity supplied now exceeds the quantity demanded, so the price falls. As it falls, consumers move down along the unchanged demand curve and buy more. The new equilibrium has a lower price and a higher quantity, and consumer surplus increases.

5. 5

   Demand and supply both increase. Analyse the effect on the equilibrium price and quantity.

   Model answer

   Both shifts raise the equilibrium quantity, so quantity definitely increases. The effects on price are opposed: the rightward shift of demand pushes the price up while the rightward shift of supply pushes it down. The change in price therefore depends on which shift is larger. If demand shifts further, price rises; if supply shifts further, price falls; and if the shifts are of equal size, price is unchanged.

6. 6

   Demand increases while supply decreases. Analyse the effect on the equilibrium price and quantity.

   Model answer

   Both changes push the price upwards, so price definitely rises. The effects on quantity are opposed: higher demand raises quantity while lower supply reduces it. The outcome for quantity therefore depends on the relative sizes of the two shifts, and cannot be determined without knowing them. This is the standard pattern in a market hit simultaneously by a demand boom and a supply disruption.

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