Econ: Change in Supply and Demand


equilibrium-price
When demand and supply are changing at the same time, the analysis becomes more complex. In such cases, we are still able to say whether one of the two variables (equilibrium price or quantity) will increase or decrease, but we may not be able to say how both will change. When the shifts in demand and supply are driving price or quantity in opposite directions, we are unable to say how one of the two will change without further information. There are four possible complex cases, where both demand and supply change at the same time:
Demand increases and supply increases
Demand increases and supply decreases
Demand decreases and supply increases
Demand decreases and supply decreases

Let us look at the first case graphically. Demand increases and supply increases, but we don’t know by how much. Let’s say that demand increases by a lot, but supply only increases by a little. The end result is that the equilibrium price and quantity increases. What if demand increases by a little and supply increases by a lot? The equilibrium price decreases while the equilibrium quantity increases. What if demand and supply both increase by a similar amount? We have a different end result. This time, the equilibrium price stays constant while the equilibrium quantity goes up. In each of these cases, we increased both demand and supply, but we ended up with three different outcomes.

If demand and supply increases, it’s hard to tell what happens to the equilibrium price, so the effect is unknown or indeterminate. The equilibrium quantity on the other hand increased in all three cases. In fact, the equilibrium quantity will always go up for every case where demand and supply both increase. If demand increases while supply stays constant, the equilibrium price will go up and the equilibrium quantity will go up. If supply increases while the demand stays constant, then the equilibrium price will go down while the equilibrium quantity goes up. Note that increasing demand and increasing supply while the other is constant has opposing effects on price. That’s why when we combine the two together, we can’t tell what happens to the equilibrium price. However, we can tell what happens to the equilibrium quantity because they both move in the same direction. We can use this technique to find out the end result of the other complex cases as well, instead of having to draw out three separate graphs every time.

Demand increases; supply increases: equilibrium price – indeterminate, equilibrium quantity – increases
Demand increases; supply decreases: equilibrium price – increases, equilibrium quantity – indeterminate
Demand decreases; supply increases: equilibrium price – decreases, equilibrium quantity – indeterminate
Demand decreases; supply decreases: equilibrium price – indeterminate, equilibrium quantity – decreases

Arrows-02-june

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