20,500,000

-20,500,000

them changes market conditions. Similarly, the direction and magnitude of changes in demand and supply that are due to uncontrollable external factors, such as income or interest rate changes, need to be understood so that managers can develop strategies and make decisions that are consistent with market conditions.

One relatively simple but useful analytical technique is to examine the effects on market equilibrium of changes in economic factors underlying product demand and supply. This is called comparative statics analysis. In comparative statics analysis, the role of factors influencing demand is often analyzed while holding supply conditions constant. Similarly, the role of factors influencing supply can be analyzed by studying changes in supply while holding demand conditions constant. Comparing market equilibrium price and output levels before and after various hypothetical changes in demand and supply conditions has the potential to yield useful predictions of expected changes.

Figures 4.6 and 4.7 illustrate the comparative statics of changing demand and supply conditions. Figure 4.6(a) combines the three automobile demand curves shown in Figure 4.2 with the automobile supply curve S8% of Figure 4.4. The demand-related effects of changes in interest rates on the market price and quantity of automobiles are illustrated. Given the supply curve S, and assuming for the moment that supply does not change in response to changes in interest rates, the intersections of the three demand curves with the supply curve indicate the market price and quantity combinations expected at different interest rates.

At the intersection of D6%, which corresponds to a 6 percent interest rate, and the supply curve S8%, supply and demand are equal at a price of $25,800 and quantity of 9.6 million units. This result is obtained by simultaneously solving the equations for D6% and S8% to find the single price and quantity that satisfies both:

comparative statics analysis

Study of changing demand and supply conditions

Comparative Statics of (A) Changing Demand or (B) Changing Supply

(a) Holding supply conditions constant, demand will vary with changing interest rates. Demand increases with a fall in interest rates; demand falls as interest rates rise.

Average price per auto ($ thousands)

Average price per auto ($ thousands)

D6%: Qd = 22,500,000 - 500P QS = -42,000,000 + 2,000P

Demand and supply are equal at a price of $25,800 because

22,500,000 - 500P = -42,000,000 + 2,000P 2,500P = 64,500,000 P = $25,800

The related quantity is found by substituting this $25,800 price into either the demand curve D6% or the supply curve Sg%:

= 9.6 million S8%: QS = -42,000,000 + 2,000($25,800) = 9.6 million

Using the same procedure to find the market clearing price-quantity combination for the intersection of D8% (the demand curve for an 8 percent interest rate), with S8% an equilibrium price of $25,000 and quantity of 8 million units is found. With interest rates at 10 percent (curve D10%), the market clearing price and quantity is $24,200 and 6.4 million units. Clearly, the level

Continued

(b) Holding demand conditions constant, supply will vary with changing interest rates. Supply falls with a rise in interest rates; supply rises as interest rates decline.

Average price per auto ($ thousands)

Average price per auto ($ thousands)

of interest rates plays an important role in the buyer's purchase decision. With higher interest rates, car buyers purchase fewer automobiles and only at progressively lower prices. In part, this reflects the fact that most car purchases are financed, and at higher interest rates, the total cost of buying an automobile is greater.

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