Interpreting Changes in Price and Quantity

Let's go back to our bread example. Suppose that you go to the store and see that the price of bread has doubled. Does the increase in price mean that the demand for bread has risen, or does it mean that bread has become more expensive to produce? The correct answer is that without more information, you don't know—it could be either one, or even both. Let's look at another example. If fewer airline tickets are sold, is the cause that airline fares have gone up or that demand for air travel has gone down? Airlines will be most interested in the answer to this question.

Economists deal with these sorts of questions all the time: When prices or quantities change in a market, does the situation reflect a change on the supply side or the demand side? Sometimes, in simple situations, looking at price and quantity simultaneously gives you a clue about whether it's the supply curve that's shifted or the demand curve. For example, a rise in the price of bread accompanied by a decrease in quantity suggests that the supply curve has shifted to the left (a decrease in supply). A rise in price accompanied by an increase in quantity indicates that the demand curve for bread has probably shifted to the right (an increase in demand).

This point is illustrated in Figure 3-9. In both panel (a) and panel (b), quantity goes up. But in (a) the price rises, and in (b) the price falls. Figure 3-9

(a) shows the case of an increase in demand, or a shift in the demand curve. As a result of the shift, the equilibrium quantity demanded increases from 10 to 15 units. The case of a movement along the demand curve is shown in Figure 3-9 (b). In this case, a supply shift changes the market equilibrium from point E to point E". As a result, the quantity demanded changes from 10 to 15 units. But demand does not change in this case; rather, quantity demanded increases as consumers move along their demand curve from E to E" in response to a price change.

The elusive concept of equilibrium

The notion of equilibrium is one of the most elusive concepts of economics. We are familiar with equilibrium in our everyday lives from seeing, for example, an orange sitting at the bottom of a bowl or a pendulum at rest. In economics, equilibrium means that the different forces operating on a market are in balance, so the resulting price and quantity reconcile the desires of purchasers and suppliers.Too low a price means that the forces are not in balance, that the forces attracting demand are greater than the forces attracting supply, so there is excess demand, or a shortage. We also know that a competitive market is a mechanism for producing equilibrium. If the price is too low, demanders will bid up the price to the equilibrium level.

The notion of equilibrium is tricky, however, as is seen by the statement of a leading pundit: "Don't lecture me about supply and demand equilibrium.The supply of oil is always equal to the demand for oil. You simply can't tell the difference." The pundit is right in an accounting sense.

Clearly the oil sales recorded by the oil producers should be exactly equal to the oil purchases recorded by the oil consumers. But this bit of arithmetic cannot repeal the laws of supply and demand. More important, if we fail to understand the nature of economic equilibrium, we cannot hope to understand the way that different forces affect the marketplace.

In economics, we are interested in knowing the quantity of sales that will clear the market, that is, the equilibrium quantity. We also want to know the price at which consumers willingly buy what producers willingly sell. Only at this price will both buyers and sellers be satisfied with their decisions. Only at this price and quantity will there be no tendency for price and quantity to change. Only by looking at the equilibrium of supply and demand can we hope to understand such paradoxes as the fact that im-

migration may not lower wages in the affected cities, that land taxes do not raise rents, and that bad harvests raise (yes, raise!) the incomes of farmers.

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