3.3 Changes in Equilibrium Price and Quantity: The Four-Step Process
3 min read•june 24, 2024
Markets constantly adjust to find balance between supply and demand. The four-step process helps us understand how is reached and how it changes. By analyzing shifts in demand and supply curves, we can predict new equilibrium prices and quantities.
Real-world examples, like gas prices affected by oil supply and seasonal demand, illustrate these concepts. Understanding the difference between movements along curves and shifts of entire curves is crucial for accurately predicting market outcomes and avoiding common errors in analysis.
The Four-Step Process and Changes in Equilibrium
Four-step process for market equilibrium
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- Step 1: Determine the
- Identify factors affecting demand (income, preferences, prices of related goods, expectations, number of buyers)
- Plot demand curve on graph with price on vertical axis and quantity on horizontal axis
- Step 2: Determine the
- Identify factors affecting supply (input prices, technology, expectations, government policies, number of sellers)
- Plot supply curve on same graph as demand curve
- Step 3: Find equilibrium point
- Locate intersection point of demand and supply curves
- Represents and quantity
- Step 4: Describe equilibrium
- State equilibrium price () and ()
- At equilibrium, equals ()
Effects of demand and supply shifts
-
- Increase in demand shifts curve right, leads to higher equilibrium price and quantity (new product becomes popular)
- Decrease in demand shifts curve left, results in lower equilibrium price and quantity (health concerns reduce demand for a product)
- Factors shifting demand: income (higher income increases demand for ), preferences (changing tastes), prices of related goods (substitute price increase boosts demand), expectations (anticipating future price increases), number of buyers (population growth expands market size)
-
- Increase in supply shifts curve right, causes lower equilibrium price and higher equilibrium quantity (technological advancement reduces production costs)
- Decrease in supply shifts curve left, leads to higher equilibrium price and lower equilibrium quantity (natural disaster disrupts production)
- Factors shifting supply: input prices (higher costs reduce supply), technology (innovations expand output), expectations (anticipating future price changes), government policies (taxes, subsidies, regulations), number of sellers (more competitors boost supply)
Construction of real-world demand-supply graphs
- Identify relevant factors affecting demand and supply in given scenario (gas prices affected by global oil supply and seasonal driving demand)
- Determine direction and magnitude of shifts in demand and/or supply curves (oil supply disruption sharply reduces supply, summer travel significantly increases demand)
- Plot initial and new demand and supply curves on graph (show original equilibrium and shifted curves)
- Locate initial and new equilibrium points (original price 4.50/gallon)
- Compare changes in equilibrium price and quantity (50% price increase, 20% quantity decrease)
Curve movements vs curve shifts
- Movements along curve
- Caused by price changes, other factors held constant
- Move along existing demand or supply curve
- Demand: price increase decreases quantity demanded (move up and left along curve), price decrease increases quantity demanded (move down and right)
- Supply: price increase increases quantity supplied (move up and right along curve), price decrease reduces quantity supplied (move down and left)
- Shifts of entire curves
- Caused by changes in non-price factors
- Shift entire demand or supply curve to new position
- Demand shifts: income (normal vs ), preferences (fashion trends), related goods prices (substitutes and complements), expectations (future price changes), number of buyers (demographic shifts)
- Supply shifts: input prices (material and labor costs), technology (productivity gains), expectations (planned production changes), government policies (carbon taxes), number of sellers (industry competition)
- Do not confuse with movements along existing curves (common error to mix up)
Market Forces and Equilibrium Dynamics
- of supply and demand interact to determine equilibrium
- occurs when quantity supplied exceeds quantity demanded at a given price
- Puts downward pressure on price
- happens when quantity demanded exceeds quantity supplied at a given price
- Creates upward pressure on price
- measures responsiveness of quantity demanded or supplied to price changes
- Affects the magnitude of price and quantity adjustments
- analyzes how equilibrium changes when underlying market conditions shift
Key Terms to Review (21)
Comparative Statics: Comparative statics is the analysis of how an economic system changes from one equilibrium state to another in response to a change in an underlying parameter or exogenous variable. It examines the differences between two distinct equilibrium positions, allowing for the evaluation of the effects of policy changes or other external factors on the economic system.
Complement Goods: Complement goods are two or more products that are typically consumed or used together, as they enhance each other's utility or value. These goods are interdependent, meaning that the demand for one good is dependent on the demand for the other good(s).
Curve Shifts: Curve shifts refer to the movement of a demand or supply curve in response to changes in factors other than the price of the good. This concept is central to understanding how changes in equilibrium price and quantity occur, as outlined in the four-step process of 3.3 Changes in Equilibrium Price and Quantity.
Demand Curve: The demand curve is a graphical representation of the relationship between the price of a good or service and the quantity demanded of that good or service. It depicts how the quantity demanded changes as the price changes, ceteris paribus (all other factors remaining constant).
Equilibrium: Equilibrium is a state of balance where the forces acting on a system are in perfect harmony, resulting in no net change or movement. In the context of economics, equilibrium refers to the point where the quantity supplied and the quantity demanded of a good or service are equal, leading to a stable market price and quantity.
Equilibrium Price: Equilibrium price is the market price at which the quantity demanded and the quantity supplied are equal, resulting in a balance between buyers and sellers in a given market. This concept is central to understanding how markets function and how prices are determined.
Equilibrium Quantity: Equilibrium quantity refers to the quantity of a good or service that is demanded and supplied at the point where the market demand curve and market supply curve intersect, resulting in a balance between the quantity demanded and the quantity supplied. This concept is central to understanding the dynamics of markets for goods and services.
Inferior Goods: Inferior goods are a type of consumer good for which demand decreases as a consumer's income increases. These are goods that people tend to consume less of as they become wealthier, in contrast to normal or superior goods where demand increases with rising income.
Market Clears: The market clearing process is a fundamental concept in economics that describes the point at which the quantity supplied and the quantity demanded for a good or service are equal, resulting in an equilibrium price and quantity. This term is particularly relevant in the context of understanding changes in equilibrium price and quantity.
Market Forces: Market forces refer to the supply and demand factors that determine the price and quantity of a good or service in a free market economy. These forces drive the equilibrium price and quantity in the market, and influence the allocation of resources within the economy.
Movements Along the Curve: Movements along the curve refer to changes in the quantity demanded or supplied of a good or service in response to a change in its price, while all other factors remain constant. This concept is central to understanding the dynamics of supply and demand, and how equilibrium price and quantity are determined.
Normal Goods: Normal goods are a type of consumer good for which demand increases as a consumer's income increases. As a person's income rises, their demand for normal goods tends to rise as well, assuming other factors remain constant.
Price Elasticity: Price elasticity is a measure of the responsiveness of the quantity demanded of a good or service to changes in its price. It quantifies the degree to which the demand for a product changes when its price changes.
Quantity Demanded: Quantity demanded refers to the amount of a good or service that consumers are willing and able to purchase at a given price during a specific time period. It is a fundamental concept in microeconomics that describes the relationship between the price of a product and the amount of that product that consumers will buy.
Quantity Supplied: Quantity supplied refers to the amount of a good or service that producers are willing and able to sell at a given price during a specific time period. It is a central concept in the theory of supply and demand, which explains how market equilibrium is determined.
Shifts in Demand Curve: Shifts in the demand curve refer to changes in the quantity demanded of a good or service at each possible price, resulting in a new demand curve. This concept is crucial in understanding the four-step process of changes in equilibrium price and quantity.
Shifts in Supply Curve: A shift in the supply curve represents a change in the supply of a good or service, independent of a change in its price. This occurs when factors other than the good's own price affect the willingness and ability of producers to supply the product to the market.
Shortage: A shortage occurs when the quantity demanded of a good or service exceeds the quantity supplied at the prevailing market price. This imbalance between supply and demand results in a scarcity of the item, leading to increased competition and potential price increases.
Substitute Goods: Substitute goods are products that can be used in place of one another to satisfy a similar need or desire. These goods are considered interchangeable from the consumer's perspective, as the consumption of one good can be replaced by the consumption of the other good.
Supply Curve: The supply curve is a graphical representation of the relationship between the price of a good or service and the quantity supplied of that good or service. It depicts the willingness and ability of producers to offer their products for sale at different price levels in a given market.
Surplus: Surplus refers to the amount by which the quantity supplied of a good or service exceeds the quantity demanded at a given price. It represents a situation where there is an excess of supply over demand in the market.