Explain the determination of market equilibrium through demand and supply with the help of diagram. OR
What is the effect of simultaneous increase in demand and supply on equilibrium price? Explain with the help of diagram.
Answers
Learn how the equilibrium of a market changes when supply and demand curves increase and decrease and how different shifts in the curves can affect price.
Introduction
The demand curve shifts rightward when cookie demand increases
Rightward Demand Curve Shift
When a market is in equilibrium, the price of a good or service tends to stay the same. Equilibrium is the price at which the quantity demanded by consumers is equal to the quantity that's supplied by suppliers. When either demand or supply changes, however, the equilibrium price and quantity will also change. That's what we're talking about in this lesson - changes in the market equilibrium.
Let's look at some examples of changes in demand and supply, including an illustration of what happens when both demand and supply increase or decrease simultaneously. Before we begin, here's a helpful list of all the possible changes to equilibrium that you'll encounter in macroeconomics:
Overview of Changes in Equilibrium Prices
Shifts in the Demand Curve
(when supply is unchanged)
to the right means an increase in demand causes equilibrium to increase
to the left means a decrease in demand causes equilibrium to decrease
Shifts in the Supply Curve
(when demand is unchanged)
to the right means an increase in supply causes equilibrium to decrease
to the left means a decrease in supply causes equilibrium to increase
As you can see, an increase in demand causes the equilibrium price to rise. On the other hand, a decrease in demand causes the equilibrium price to fall. An increase in supply causes the equilibrium price to fall, while a decrease in supply causes the equilibrium price to rise.
Well, as it turns out, I'm thinking about chocolate chip cookies right now. For some reason, talking about macroeconomics really increases my demand for cookies. Ever since they removed the Cookie Monster from public television's 'Sesame Street,' I've noticed a remarkable decrease in the supply of cookies in my house; however, my demand for cookies has only gone up and up and up! So, let's look at an example of equilibrium in the cookie market and see what happens when things change.
Let's say the equilibrium price for a chocolate chip cookie is $3. Here's an example of the supply and demand curves, with an equilibrium price of $3, which is at the intersection of the supply and demand curves. At a price of $3, consumers will demand and suppliers will supply 5,000 cookies per year. Wow, that sounds great, doesn't it? What happens when something causes a shift in demand? Well, I'm glad you asked!
A drop in cookie demand causes the demand curve to shift to the left
Leftward Demand Curve Shift
When household incomes increase by 30% this year (hey, this could happen!), that means that the demand for cookies goes up. If the demand for cookies increases, then this causes a shift of the demand curve to the right. As you can see, a new equilibrium is created after the shift. The new equilibrium price is higher than the old one because demand increased. At the new equilibrium, the price for a cookie is now $5, and the quantity demanded, which is the same as the quantity supplied, is 7,500 cookies at this higher level of price.
Okay, so now, let's say that instead of increasing, household incomes decrease this year by 30%. When they do, the demand for cookies is definitely going to go down. A decrease in the demand for cookies will cause the demand curve to shift to the left, and, assuming no change in anything else, the equilibrium price will go down. The new equilibrium price is going to be $2. At this price, only 2,500 cookies will get sold in this market instead of 5,000.
So far, we've talked about what happens to the demand for cookies. Let's look at the supply side now.
There are various things that could lead to a shift in supply, but let's say that a weird blue tornado flies through the city of Chiphaven, in West Cookieland. (It's a beautiful place. I've been there - you should go there. It's a great place for vacation - the kids would love it.) Unfortunately, half of all the cookie factories are located here in Chiphaven, and the tornado picks up all the cookie factories in the air (in addition to tens of thousands of cookies, if you can imagine that) and destroys them. Thankfully, Studio 65, the nearby disco, is perfectly intact!