2.3.2 Shifting demand and supply curves to produce a new market equilibrium Notes

At market equilibrium, both consumers and producers are satisfied and have no tendency to change their choices, unless there is a change in some non-price determinant.

Consider the market for some good $X$ (Figure 1). At first, it is in equilibrium at point $A$ with price $P_e$ and quantity $Q_e$.

Shifts in Demand

Now assume that there is a change in some non-price determinant, such as an increase in the price of a substitute of good $X$:

1. This will cause the demand for good $X$ to increase, shifting the curve to the right from $D_1$ to $D_2$ (Figure 2).
2. Hence, at the current price $P_e$, there is an excess demand from point $B$ to $A$ because the new quantity demanded $Q_1$ is higher than the quantity supplied $Q_e$ .
3. Thus (as we was in 2.3.1), the firm will increase its price until $P_1$ causing a new equilibrium point to be found at $C$ with quantity $Q_2$.

Similarly, now assume that there is the opposite effect through a non-price determinant, such as the discovery of good $X$'s harmful health effects (negative preferences and tastes):

1. This will cause the demand for good $X$ to decrease, shifting the curve to the left from $D_1$ to $D_2$.
2. Hence, at the current price $P_e$, there is an excess supply (surplus) from point $B$ to $A$ because the new quantity demanded $Q_1$ is lower than the quantity supplied $Q_e$.
3. Thus (2.3.1), the firm will decrease its price until $P_1$ causing a new equilibrium point to be found at $C$ with quantity $Q_2$.

Shifts in Supply

Now, assume some change considering non-price determinant's again but from the supply side, such as a fall of the cost of raw materials:

1. This will cause the supply for good $X$ to increase, shifting the curve to the right from $S_1$ to $S_2$ (Figure 3).
2. Hence, at the current price $P_e$, there is an excess supply from point $B$ to $A$ because the new quantity supplied $Q_1$ is higher than the quantity demanded $Q_e$ .
3. Thus (2.3.1), the firm will decrease its price (downward pressure) until $P_1$ causing a new equilibrium point to be found at $C$ with quantity $Q_2$.

Finally let there be the opposite change considering non-price determinant's, this time an increase in cost of raw materials:

1. This will cause the supply for good $X$ to decrease, shifting the curve to the left from $S_1$ to $S_2$ (Figure 4).
2. Hence, at the current price $P_e$, there is an excess demand from point $B$ to $A$ because the new quantity supplied $Q_1$ is lower than the quantity demanded $Q_e$.
3. Thus (2.3.1), the firm will increase its price (upward pressure) until $P_1$ causing a new equilibrium point to be found at $C$ with quantity $Q_2$.