Professional Documents
Culture Documents
ECO2201 - Slides - 2.3 - Changes in Market Equilibrium
ECO2201 - Slides - 2.3 - Changes in Market Equilibrium
ECO2201 - Slides - 2.3 - Changes in Market Equilibrium
Chapter 4 :The Market Forces
of Supply and Demand
Changes in Market
Equilibrium
Lesson 2.3
Road Map
1. Overview
2. Changes in Market Equilibrium
– Finding the New Equilibrium
• Review & Exercise
2
1. Overview
• Changes in Demand, Supply, and Equilibrium
– Often in economics, we will be asked to compare equilibria after certain
things (fluctuation in market conditions ) occur.
– That is, demand and supply shifters will lead to changes in demand and/or
supply.
• E.g. what will happen to the market for rice if the government provides
subsidies to rice farmers?
– Given the change in demand and supply, we will have a new market
equilibrium.
• Higher/lower market equilibrium price (Peq) and/or quantity (Qeq)
3
1. Overview
• We can use the same analysis of the market forces to answer
such a question.
1. Graph
2. Table
3. Mathematical equations
4
2. Changes in equilibrium
Three steps to analyzing changes in equilibrium
1. Decide whether the event shifts the supply curve, the
demand curve, or, in some cases, both curves
2. Decide whether the curve shifts to the right or to the left
3. Use the supply‐and‐demand diagram
• Compare the initial and the new equilibrium
• Effects on equilibrium price and quantity
5
Example 1: The Market for Hybrid Cars
price of P
hybrid cars S1
P1
quantity
of
D1 hybrid
Q cars
Q1
6
Example 1: A Shift in Demand
EVENT TO BE ANALYZED: P
S1
Increase in the price of gas.
STEP 1: D curve shifts Peq2
because price of gas affects demand for
hybrids. (S curve does not shift, Peq1
because price of gas does not affect
cost of producing hybrids)
STEP 2: D shifts right
D1 D2
because high gas price makes hybrids
more attractive relative to other Qeq1 Qeq2 Q
cars.
STEP 3: The shift causes an increase in
price and quantity of hybrid cars.
7
Example 2: A Shift in Supply
EVENTS TO BE ANALYZED:
P
New technology reduces cost of S1 S2
producing hybrid cars.
STEP 1: S curve shifts
because event affects cost of
production. (D curve does not shift, Peq1
because production technology is not P
eq2
one of the factors that affect demand)
STEP 2: S shifts right
D1
because event reduces cost, makes
production more profitable at any given Qeq1 Qeq2 Q
price.
STEP 3: The shift causes price to fall and
quantity to rise.
8
Example 3: A Shift in Both Supply and Demand
EVENT TO BE ANALYZED: P
Price of gas rises AND new S1 S2
technology reduces production
costs Peq2
STEP 1: Both curves shift. Peq1
STEP 2: Both shift to the right.
STEP 3: Q rises, but the effect on P D2
D1
is ambiguous:
Q
If demand increases more than
Qeq1 Qeq2
supply, P rises.
9
Example 3: A Shift in Both Supply and Demand
EVENTS TO BE ANALYZED: P
Price of gas rises AND new S1 S2
technology reduces production
costs
Peq1
Peq2
STEP 3: Q rises, but the effect on P
D1 D2
is ambiguous:
Q
Qeq1 Qeq2
• But if supply increases more
than demand, P falls.
10
2. Finding the New Equilibrium
• Possible Changes in Equilibrium
Change in Supply Change in Demand Effect on Peq Effect on Qeq
Increase Increase Indeterminate Increase
Increase Decrease Decrease Indeterminate
Decrease Increase Increase Indeterminate
Decrease Decrease Indeterminate Decrease
– If only demand or supply curve shifts (not both),
both Peq and Qeq are determinate.
– If both demand and supply curves shift at the same time, either Peq or Qeq
will be indeterminate.
11
Review & Exercise
Review
• To analyze how any event influences a market, we use the supply‐
and‐demand diagram to examine how the event affects the
equilibrium price and quantity.
1. Decide whether the event shifts the supply curve or the demand
curve (or both).
2. Decide in which direction the curve shifts.
3. Compare the new equilibrium with the initial one.
• In market economies, prices are the signals that guide economic
decisions and thereby allocate scarce resources.
13
Exercise 1: Shifts in supply and demand
Use the three‐step method to analyze the effects of each event on
the equilibrium price and quantity of music downloads.
Event A: A fall in the price of music CDs
Event B: Sellers of music downloads negotiate a reduction in the
royalties they must pay for each song they sell.
Event C: Events A and B both occur.
14
Exercise 1: Shifts in supply and demand
A. A fall in the price of music CDs The market for
P music downloads
S1
STEPS:
Peq1
1. D curve shifts
Peq2
2. D curve shifts left
15
Exercise 1: Shifts in supply and demand
The market for
B. Fall in cost of royalties P music downloads
S1 S2
STEPS:
Peq1
1. S curve shifts (Royalties
Peq2
are part of sellers’ costs)
2. S curve shifts right
D1
3. P falls, Q rises Q
Qeq1 Qeq2
16
Exercise 1: Shifts in supply and demand
C. Fall in price of music CDs and fall in cost of royalties
STEPS:
1. Both curves shift (see parts A & B)
2. D shifts left, S shifts right
3. P falls.
Effect on Q is ambiguous:
‐ the fall in demand reduces Q,
‐ the increase in supply increases Q.
17
Exercise 2: Equation Analysis
• Suppose the demand and supply functions for cars are
as follows.
– QD = 12,000 – 2P
– QS = 6,000 + P
– Where P is price in thousand baht and Q is quantity in cars
per year.
• Find equilibrium price and quantity.
18
Exercise 2: Equation Analysis
• So, we have
12,000 – 2P = 6,000 + P
3P = 6,000
Peq = 2,000 thousand baht = 2 million baht
19
Exercise 2: Equation Analysis
20
Exercise 3: Graph Analysis
• Modified from Mankiw
• Suppose we observe that both the equilibrium price of cream cheese and
the equilibrium quantity of bagels have risen.
• What could be responsible for this pattern?
a) A fall in the price of flour (↓Pflour)? OR
b) A fall in the price of milk (↓Pmilk)?
– We are asked to analyze two sets of three markets together:
i. Flour, bagel, and cream cheese.
ii. Milk, bagel, and cream cheese.
21
Exercise 3: Graph Analysis
• Recall, we need to answer the following questions:
1. What curve will shift: demand curve, supply curve, or both?
2. Which direction would the curve(s) shift: right or left?
3. What is the determinant (factor) causes such a shift?
4. What happens to Peq and Qeq? (Adjustment process) We are given this!
• Recap, we want ↑Peq of cream cheese, and ↑Qeq of bagels because of
either
a) A fall in the price of flour, or
b) A fall in the price of milk
22
Exercise 3: Graph Analysis
• What do we know about flour and milk?
– Flour is used to make bagels.
– Milk is used to make cream cheese.
– Changes in the price of flour and milk will result in a change in the
price of bagels and cream cheese.
• Bagels and cream cheese are complement goods (because
people eat them together).
– So, a change in the bagel price will affect the cream cheese
demand, and vice versa.
23
Exercise 3: Graph Analysis
• Let’s begin with a) a fall in the
S0
P Temp price of flour (↓Pflour).
surplus S1 • If the price of flour falls, then the
eq0
Peq0 supply of bagels will shift
Peq1
eq1 rightward because it is cheaper
to make bagels.
D
• This results in lower Peq; higher
✔
0 Qeq0 Qeq1 Bagels
Market for Bagels
Qeq of bagels.
24
Exercise 3: Graph Analysis
• A fall in the price of bagel (↓Pbagel)
P will result in an increase in demand
S
for cream cheese given that they
P1 eq1 are complement goods.
P0 eq0
• Demand for cream cheese shifts
Temp
D1 rightward.
shortage
D0 • This results in higher Peq; higher
✔
0 Q0 Q1 cream cheese
Qeq of cream cheese.
Market for Cream Cheese
25
Exercise 3: Graph Analysis
• In sum, when the price of flour falls, we have
– A decrease in the price of bagels, and an increase in quantity of
bagels.
– An increase in both the price and the quantity of cream cheese.
– That is,
↓Pflour ⇒ ↓Pbagel ; ↑ Qbagel ⇒ ↑ Pcream cheese ; ↑ Qcream cheese
This is, therefore, the correct answer!
• You can try at home why choice b) a fall in the price of milk (↓Pmilk) is
an incorrect answer.
26