Thrfp Steps to Analyzing Changes in Equilibrium

So far, we- have seen how supply and demand together determine a market's equilibrium, which in turn determines the price and quantity of the good that buyers purchase and sellers produce. The equilibrium price and quantity depend on the position of the supply and demand curves. When some event shifts one of these curves, the equilibrium in the market changes, resulting in a new price and a new quantity exchanged between buyers and sellers.

When analyzing how some event affects the equilibrium in a market, we proceed in three steps. First, we decide whether the event shifts the supply curve, the demand curve, or, in some cases, both curves. Second, we decide whether the curve shifts to the right or to the left. Third, we use the supply-and-demand diagram to compare the initial and the new equilibrium, which shows how the shift affects the equilibrium price and quantity. Table 3 summarizes these three steps. To see how this recipe is used, let's consider various events that might affect the market for ice cream.

Example: A Change in Market Equilibrium Due to a Shift in Demand Suppose that one summer the weather is very hot. How does this event affect the market for ice cream? To answer this question, let's follow our three steps.

1. The hot weather affects the demand curve by changing people's taste for ice cream. That is, the weather changes the amount of ice cream that people want to buy at any given price. The supply curve is unchanged because the weather does not directly affect the- firms that sell ice cream.

2. Because hot weather makes people want to cat more ice cream, the demand curve shifts to the right. Figure 10 shows this increase in demand as the shift in the demand curve from D, to D,. This shift indicates that the quantity of ice cream demanded is higher at every price.

3. As Figure 10 shows, the increase in demand raises the equilibrium price from $-2.00 to 32.50 and the equilibrium quantity from 7 to 10 cones. In other words, the hot weather increases the price of ice cream and the quantity of ice cream sold.

Shifts in Curves versus Movements along Curves Notice that when hot weather increases the demand for ice cream and drives up the price, the quantity of ice cream that firms supply rises, even though the supply curve remains the same. In this case, economists say there has been an increase in "quantity supplied" but no change in "supply."

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Supply refers to the position of the supply curve, whereas the quantity iupplietl refers to the amount suppliers wish to sell. In this example, supply does not change because the weather does not alter firms' desire to sell at any given price. Instead, the hot weather alters consumers' desire to buy at any given price and thereby shifts the demand curve to the right. The increase; in demand causes the equilibrium price to rise- When the price rises, the quantity supplied rises. This increase in quantity supplied is represented by the movement along the supply curve.

To summarize, a shift w the supply curve is called a "change in supply," and a shift in the demand curve is called a "change in demand." A movement along a fixed supply curve is called a "change in the quantity supplied," and a movement fl/wt/; a fixed demand curve is called a "change in the quantity demanded."

Example: A Change in Market Equilibrium Due to a Shift in Supply Suppose that during another summer, a hurricane destroys part of the sugarcane crop and drives up the price of sugar. How does this event affect the market for ice cream? Once again, to answer this question, we follow our three steps.

1. The change in the price of sugar, an input into making ice cream, affects the supply curve. By raising the C<»sts of production, it reduces the amount of ice cream that firms produce and sell at any given price. The demand curve does not change because the higher cost of inputs does not directly affect the amount of icecream households wish to buy.

2. The supply curve shifts to the left because, at every price, the total amount that firms are willing and able to sell is reduced. Figure 11 illustrates this decrease in supply as a shift in the supply curve from S, to S..

3. As Figure 11 dmws, Hit- shift in the supply curve raises the equilibrium price from $2 XXI to $2.50 and lowers the equilibrium quantity from 7 to 4 cones As a result of the sugar price increase, the price of ice cream rises, and the quantity of ice cream sold falls.

Exampl«: Shifts in Both Supply and Domand Now suppose that a heat wave and a hurricane occur during the same summer. To analyze this combination of events, we again follow our three steps.

1. We determine that both curves must shift. The hot weather affects the demand curve btvause it alters the amount of ice cream that households want to buy at any given price. At the sime time, when the hun-icane drives up sugar prices, it alters the supply curve for ice cream because it changes the amount of ice cream that firms want to sell at any given price.

2. The curves shift in the same directions as they did in our previous analysis: The demand curve shifts to the right, and the supply curve shifts to the left. Figure 12 illustrates these shifts.

3. As Figure 12 shows, two possible outcomes might result depending on the relative size of the demand and supply shifts. In both cases, the equilibrium price rises. In panel (a), where demand increases substantially while supply falls just a little, the equilibrium quantity also rises. By contrast, in panel (b), where supply falls substantially while demand rises just a little, the equilibrium quantity falls- Thus, these events certainly raise the price of ice cream, but their impact on the amount of ice cream sold is ambiguous (that is, it could go either way).

Summary Wo have just seen three examples of how to use supply and demand curves to analyze a change in equilibrium. Whenever an event shifts the supply curve, the demand curve, or perhaps both curves, you can use these tools to predict how the event will alter tin." amount sold in equilibrium and the price at which the good is s*.'Id. Table 4 shows the predicted outcome for any combination of shifts in the two curves. To make sure you understand how to use the tools of supply and demand, pick a few entries in this table and make sure you can explain to yourself why the table contains the predict inn it does.

QUICK QUIZ On «ho appropriate diagram, show what happons to tho market for pizza if th* price of tomato« rlws. • On a »eparat* digram, »how what happens to th« market for pirza if the price of hamburgers fall».

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