Module 7 Changes in Equilibrium

What You Will Learn 1 How equilibrium price and quantity are affected when there is a change in either supply or demand How equilibrium price and quantity are affected when there are simultaneous changes in both supply and demand 2

Equilibrium and Shifts of the Demand Curve Price of cotton An increase in demand… Supply … leads to a movement along the supply curve due to a higher equilibrium price and higher equilibrium quantity. E2 P2 Price rises E1 P1 Figure Caption: Figure 7.1: Equilibrium and Shifts of the Demand Curve The original equilibrium in the market for coffee is at E1, at the intersection of the supply curve and the original demand curve, D1. A rise in the price of tea, a substitute, shifts the demand curve rightward to D2. A shortage exists at the original price, P1, causing both the price and quantity supplied to rise, a movement along the supply curve. A new equilibrium is reached at E2, with a higher equilibrium price, P2, and a higher equilibrium quantity, Q2. When demand for a good or service increases, the equilibrium price and the equilibrium quantity of the good or service both rise. Note to the instructor: An example from sports: The recent successes of the Red Sox (Boston’s baseball team) caused an increase in demand for the tickets of Red Sox games. In 10 years, global warming may increase the demand for land in parts of the world earlier considered too cold. Question for Class Discussion: Coffee and tea are substitutes: if the price of tea rises (falls), the demand for coffee will increase (decrease). But how does the price of tea affect the market for coffee? D2 D1 Quantity rises Q1 Q2 Quantity of cotton

Equilibrium and Shifts of the Supply Curve Price of cotton S2 S1 A decrease in supply… E2 P2 … leads to a movement along the demand curve due to a higher equilibrium price and lower equilibrium quantity. Price rises P1 E1 A drought causes a fall in the supply of cotton. How does this negative supply shock affect the market for coffee? Figure Caption: Figure 7.2: Equilibrium and Shifts of the Supply Curve The original equilibrium in the market for cotton is at E1. A drought causes a fall in the supply of cotton and shifts the supply curve leftward from S1 to S2. A new equilibrium is established at E2, with a higher equilibrium price, P2, and a lower equilibrium quantity, Q2. Note to the instructor: An example from sports: The recent successes of Red Sox (Boston’s baseball team) caused an increase in demand for the tickets of Red Sox games. In 10 years, global warming may increase the demand for land in parts of the world earlier considered too cold. Demand Q2 Q1 Quantity of cotton Quantity falls

Simultaneous Shifts of Supply and Demand Curves (a) One possible outcome: Price rises, quantity rises Price of cotton Small decrease in supply S2 S1 Two opposing forces determining the equilibrium quantity. E2 The increase in demand dominates the decrease in supply. P2 Figure Caption: Figure 7.3 (a) There is a simultaneous rightward shift of the demand curve and leftward shift of the supply curve. Here the increase in demand is relatively larger than the decrease in supply, so the equilibrium price and equilibrium quantity both rise. E1 P1 D2 D1 Large increase in demand Q1 Q2 Quantity of cotton

Simultaneous Shifts of Supply and Demand Curves (b) Another possible outcome: Price rises, quantity falls Price of cotton Two opposing forces determining the equilibrium quantity. Large decrease in supply S2 S1 E2 P2 E1 Small increase in demand Figure Caption: Figure 7.3 (b) There is also a simultaneous rightward shift of the demand curve and leftward shift of the supply curve. Here the decrease in supply is relatively larger than the increase in demand, so the equilibrium price rises and the equilibrium quantity falls. P1 D2 D1 Q2 Q1 Quantity of cotton

Economics in Action The Rice Run of 2008 In April 2008, the price of rice exported from Thailand reached $950 per ton, up from $360 at the beginning of 2008. The factors, related to both demand and supply, included growing incomes in China and India, drought in Australia, and pest infestation in Vietnam. But it was hoarding by farmers, panic buying by consumers, and an export ban by India that explained the rapid rise in price.

Simultaneous Shifts of Supply and Demand Summary Simultaneous Shifts of Supply and Demand Supply Increases Supply Decreases Demand Increases Price: ambiguous Quantity: up Price: up Quantity: ambiguous Demand Decreases Price: down Quantity: down