ECO 120 - Global Macroeconomics Taggert J. Brooks

Supply and demand Changes in Equilibrium Module 07 Supply and demand Changes in Equilibrium

Equilibrium and Shifts of the Demand Curve Price of coffee beans An increase in demand… Supply … leads to a movement along the supply curve due to a higher equilibrium price and higher equilibrium quantity. E 2 P 2 Price rises E 1 P 1 D 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 Socks 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? 2 D 1 Q Q 1 2 Quantity of coffee beans

Equilibrium and Shifts of the Supply Curve Price of coffee beans S S A decrease in supply… 2 1 E P 2 2 … leads to a movement along the demand curve due to a higher equilibrium price and lower equilibrium quantity. Price rises P E 1 1 A drought causes a fall in the supply of coffee beans. 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 coffee beans is at E1. A drought causes a fall in the supply of coffee beans 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 Socks (Boston’s Baseball Team) caused an increase in demand for the tickets of Red Socks games. In 10 years, global warming may increase the demand for land in parts of the world earlier considered “too cold.” Demand Q Q Quantity of coffee beans 2 1 Quantity falls

Simultaneous Shifts of Supply and Demand Curves (a) One possible outcome: Price Rises, Quantity Rises Price of coffee Small decrease in supply S S Two opposing forces determining the equilibrium quantity. 2 1 E 2 P 2 The increase in demand dominates the decrease in supply. E 1 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. P 1 D 2 D 1 Large increase in demand Q Quantity of coffee 1 Q 2

Simultaneous Shifts of Supply and Demand Curves (b) Another Possibility Outcome: Price Rises, Quantity Falls Price of coffee Large decrease in supply S 2 Two opposing forces determining the equilibrium quantity. S 1 E 2 P 2 E Small increase in demand 1 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. P 1 D 2 D 1 Q Q Quantity of coffee