BackDemand, Supply, and Market Equilibrium: Key Concepts and Applications
Study Guide - Smart Notes
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Demand and Supply Analysis
Shifts in Demand Curves
The demand curve shows the relationship between the price of a good and the quantity demanded, holding all else constant. Changes in non-price factors, such as consumer tastes or preferences, cause the entire demand curve to shift.
Decrease in Taste or Preference: A decrease in consumer preference for a good shifts the demand curve to the left, from D1 to D2.
Movement Along vs. Shift of Demand Curve: A movement along the curve (from point A to B) is caused by a change in price, while a shift (from D1 to D2) is caused by a change in a non-price determinant.
Example: If consumers suddenly prefer tea over coffee, the demand curve for coffee shifts leftward.
Shifts in Supply Curves
The supply curve shows the relationship between the price of a good and the quantity supplied. Changes in factors such as input prices, technology, or the number of firms shift the supply curve.
Decrease in Supply: Occurs when the supply curve shifts to the left, indicating that at every price, less is supplied.
Causes of Decrease in Supply:
An increase in the price of inputs (e.g., higher wages for seamstresses increases the cost of producing women's clothing, shifting supply left).
An increase in the price of alternative products that firms could produce instead.
A decrease in the number of firms in the market.
Example: If the price of milk rises, the supply of cookies (which use milk as an input) may decrease.
Market Equilibrium
Determining Equilibrium Price and Quantity
Market equilibrium occurs where the quantity demanded equals the quantity supplied. This is represented graphically by the intersection of the demand and supply curves.
Equilibrium Price (Pe): The price at which Qd = Qs.
Equilibrium Quantity (Qe): The quantity bought and sold at the equilibrium price.
Example Table:
Price | Quantity Demanded | Quantity Supplied |
|---|---|---|
$20 | 0 | 6 |
$15 | 2 | 5 |
$10 | 4 | 4 |
$5 | 6 | 3 |
At $10, equilibrium is reached: Qd = Qs = 4.
At $15, Qd = 2 and Qs = 5 (excess supply).
Effects of Changes in Market Conditions
Changes in demand or supply shift the respective curves, leading to new equilibrium prices and quantities.
Increase in Input Costs: Shifts supply left, raising equilibrium price and lowering equilibrium quantity.
Decrease in Demand: Shifts demand left, lowering both equilibrium price and quantity.
Graphical Analysis of Market Changes
Panel Analysis: Effects of Input Price Changes
When the wages of seamstresses rise, the cost of producing women's clothing increases, causing the supply curve to shift leftward (S1 to S2), resulting in a higher equilibrium price and lower equilibrium quantity.
Panel Identification: The correct panel shows a leftward shift of the supply curve with the demand curve unchanged.
General Rule: Any increase in input prices shifts supply left; any decrease shifts supply right.
Key Terms and Formulas
Demand Curve: Shows the relationship between price and quantity demanded.
Supply Curve: Shows the relationship between price and quantity supplied.
Equilibrium:
Excess Supply (Surplus): Occurs when at a given price.
Excess Demand (Shortage): Occurs when at a given price.
