Three 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 of the good and the amount of the good that buyers purchase and sellers produce. Of course, 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. The analysis of such a change is called comparative statics because it involves comparing two static situations—an old and a new equilibrium.

When analyzing how some event affects 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 examine how the

Figure 4-9

Markets Not in Equilibrium. In panel (a), there is a surplus. Because the market price of $2.50 is above the equilibrium price, the quantity supplied (10 cones) exceeds the quantity demanded (4 cones). Suppliers try to increase sales by cutting the price of a cone, and this moves the price toward its equilibrium level. In panel (b), there is a shortage. Because the market price of $1.50 is below the equilibrium price, the quantity demanded (10 cones) exceeds the quantity supplied (4 cones). With too many buyers chasing too few goods, suppliers can take advantage of the shortage by raising the price. Hence, in both cases, the price adjustment moves the market toward the equilibrium of supply and demand.

(a) Excess Supply

(a) Excess Supply

Quantity Quantity Ice-Cream Cones demanded supplied

Quantity Quantity Ice-Cream Cones demanded supplied

(b) Excess Demand

(b) Excess Demand

4 7 10 Quantity of

Quantity Quantity Ice-Cream Cones supplied demanded

4 7 10 Quantity of

Quantity Quantity Ice-Cream Cones supplied demanded

shift affects the equilibrium price and quantity. Table 4-7 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 i n 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 eat more ice cream, the demand curve shifts to the right. Figure 4-10 shows this increase in demand as the shift in the demand curve from D1 to D2. This shift indicates that the quantity of ice cream demanded is higher at every price.

3. As Figure 4-10 shows, the increase in demand raises the equilibrium price from $2.00 to $2.50 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 drives up the price of ice cream, 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."

1. Decide whether the event shifts the supply curve or demand curve (or perhaps both).

2. Decide which direction the curve shifts.

3. Use the supply-and-demand diagram to see how the shift changes the equilibrium.

Table 4-7

A Three-Step Program for Analyzing Changes in Equilibrium

Figure 4-10

How an Increase in Demand Affects the Equilibrium. An event that raises quantity demanded at any given price shifts the demand curve to the right. The equilibrium price and the equilibrium quantity both rise. Here, an abnormally hot summer causes buyers to demand more ice cream. The demand curve shifts from D1 to D2, which causes the equilibrium price to rise from $2.00 to $2.50 and the equilibrium quantity to rise from 7 to 10 cones.

Price of Ice-Cream Cone

Price of Ice-Cream Cone

3. . . . and a higher ^^ Ice-Cream Cones quantity sold.

3. . . . and a higher ^^ Ice-Cream Cones quantity sold.

"Supply" refers to the position of the supply curve, whereas the "quantity supplied" 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. 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 in 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 along a fixed demand curve is called a "change in the quantity demanded."

Example: A Change in Supply Suppose that, during another summer, an earthquake destroys several ice-cream factories. How does this event affect the market for ice cream? Once again, to answer this question, we follow our three steps.

1. The earthquake affects the supply curve. By reducing the number of sellers, the earthquake changes the amount of ice cream that firms produce and sell at any given price. The demand curve is unchanged because the earthquake does not directly change the amount of ice cream 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 4-11 illustrates this decrease in supply as a shift in the supply curve from S1 to S2.

Price of Ice-Cream Cone

Price of Ice-Cream Cone

Figure 4-11

How a Decrease in Supply Affects the Equilibrium. An event that reduces quantity supplied at any given price shifts the supply curve to the left. The equilibrium price rises, and the equilibrium quantity falls. Here, an earthquake causes sellers to supply less ice cream. The supply curve shifts from Sj to S2, which causes the equilibrium price to rise from $2.00 to $2.50 and the equilibrium quantity to fall from 7 to 4 cones.

Quantity of Ice-Cream Cones

Figure 4-11

How a Decrease in Supply Affects the Equilibrium. An event that reduces quantity supplied at any given price shifts the supply curve to the left. The equilibrium price rises, and the equilibrium quantity falls. Here, an earthquake causes sellers to supply less ice cream. The supply curve shifts from Sj to S2, which causes the equilibrium price to rise from $2.00 to $2.50 and the equilibrium quantity to fall from 7 to 4 cones.

Quantity of Ice-Cream Cones

3. As Figure 4-11 shows, the shift in the supply curve raises the equilibrium price from $2.00 to $2.50 and lowers the equilibrium quantity from 7 to 4 cones. As a result of the earthquake, the price of ice cream rises, and the quantity of ice cream sold falls.

Example: A Change in Both Supply and Demand Now suppose that the hot weather and the earthquake occur at the same time. 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 because it alters the amount of ice cream that households want to buy at any given price. At the same time, the earthquake alters the supply curve 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 4-12 illustrates these shifts.

3. As Figure 4-12 shows, there are two possible outcomes that 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.

Figure 4-12

A Shift in Both Supply and Demand. Here we observe a simultaneous increase in demand and decrease in supply. Two outcomes are possible. In panel (a), the equilibrium price rises from P1 to P2, and the equilibrium quantity rises from Q1 to Q2. In panel (b), the equilibrium price again rises from P1 to P2, but the equilibrium quantity falls from Q1 to Q2.

(a) Price Rises, Quantity Rises

Price of Ice-Cream Cone

(a) Price Rises, Quantity Rises

Price of Ice-Cream Cone

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