Changes in Market Equilibrium:
Impact of Increase and
Decrease
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Changes in Market Equilibrium: Impact of Increase and
Decrease!
Changes in either demand or supply cause changes in market
equilibrium. Several forces bringing about changes in demand and
supply are constantly working which cause changes in market
equilibrium, that is, equilibrium prices and quantities.
The demand may increase or decrease, the supply curves remaining
unchanged. This would cause a change in equilibrium price and
quantity.
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Similarly, the increase or decrease in supply, the demand curve
remaining constant, would have an impact on equilibrium price and
quantity. Both supply and demand for goods may change
simultaneously causing a change in market equilibrium.
Supply-demand analysis is an important tool of economics with
which we can make forecasts about how prices and quantities will
change in response to changes in demand and supply. We explain
below the impact of changes in demand and supply on equilibrium
price and quantity.
Impact of Increase in Demand on Market Equilibrium:
Increase in demand affects prices and quantities. Suppose there is
increase in income of the working class due to the enhancement of
their salaries by the Pay Commission. As a result of this increase in
income, their demand for cloth for shirting will increase causing a
shift in the entire demand curve for cloth to the right.
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This will raise the equilibrium price and quantity of cloth, the
supply curve of cloth remaining unchanged as is shown in Fig. 24.2.
It is important to understand the chain of causation which leads to
the increase in price and quantity as a result of increase in demand.
Consider Fig. 24.2, in which D0D0 and SS are the initial demand and
supply curves of cloth. The increase in income causes a shift in the
entire demand curve to the right to the new position D1D1 while the
supply curve SS remains constant. It will be observed from Fig.
24.2, that with the shift in demand curve to D1D1 at the old price
OP0 excess demand of cloth equal to E0A has emerged. This excess
demand of the good exerts upward pressure on price.
This will result in rise in price to OP where again quantity
demanded equals quantity supplied and new market equilibrium is
attained and excess demand is eliminated. It is worth noting that
increase in demand is the most important factor causing inflation,
that is, rise in prices and is generally described as demand-pull
inflation.
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Though the term inflation is used in the context of a rise in general
price level, but it has roots at the micro level (i.e., in case of
individual goods). Apart from increase in income, a favourable
change in consumer’s preferences for a particular good, rise in price
of its substitutes will also cause an increase in demand for a good.
Impact of Decrease in Demand on Market Equilibrium:
Now, take the opposite case of the impact of decrease in demand on
market equilibrium, the supply curve remaining the same. The
decrease in demand causes a shift in the entire demand curve to the
left. This is graphically shown in Fig. 24.3, where originally demand
curve D0D0 intersects the supply curve SS of eggs at point E0 and
determines equilibrium price equal to OP0 and equilibrium quantity
OQ0. Now, suppose that doctors advise the people to take less eggs
as it contains greater quantity of cholesterol which increases the
risk of heart disease.
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Consequently, demand for eggs decreases causing a shift in the
demand curve to the left to the new position D2D2. The new
equilibrium between demand and supply is attained at price P, and
quantity Q2 which are lower than the initial equilibrium price
OP0 and quantity OQ0.
Thus, the decrease in demand leads to the fall in both price and
quantity. How does this come about? With the decrease in demand
and consequently leftward shift in the demand curve to D2D2 supply
curve remaining unchanged, at the original price OP0, the surplus
E0B of the quantity supplied over the quantity demanded emerges
which exerts a downward pressure on price.
The sellers which cannot sell the quantity which they want to sell at
the original price will make offers to sell eggs at a lower price. As a
result, price will fall. As price falls, the quantity supplied of eggs is
reduced. At the new price OP2 the quantity supplied again equals
quantity demand and surplus is eliminated.
Apart from the changes in preferences for a good as in case of eggs
considered above, the decrease in incomes of the people such as
when a large number of people are rendered unemployed during
depression, the reduction of crop production in agriculture due to
failure of Monsoon leading to the drop in incomes of the Indian
farmers can also cause a decrease in demand for goods resulting in
lowering of prices and quantities of goods.
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Impact of Changes in Supply on Market Equilibrium:
Now, we explain the impact of changes in supply on price and
output of commodity, the demand for the commodity remaining the
same. Let us first examine the case of increase in supply. Suppose in
a year there is good Monsoon in India yielding bumper crop of
wheat.
This will increase the supply of wheat in the market causing a shift
in its supply curve to the right. The impact of increase in supply of
wheat on equilibrium price and quantity is graphically depicted in
Fig. 24.4. Originally, demand curve DD and supply curve 55 of
wheat intersect at point E and determine equilibrium price equal to
OP and equilibrium quantity OQ exchanged between the sellers and
buyers.
Now, due to good monsoon resulting in bumper crop of wheat the
supply curve of wheat shifts to the right from SS to the new position
S1S1. The new supply curve S1S1 intersects the given demand curve
DD at point E1, at which the new lower equilibrium price OP1 and
larger quantity OQ1 are determined. Thus, the increase in supply
leads to the fall in price and increase in equilibrium quantity.
Improvements in technology, reduction in the prices of factors and
resources used in the production of a commodity or lowering of
excise duty on a commodity also leads to the increase in supply of
the commodity.
For example, in recent years improvements in technology in the
manufacture of personal computers have served to increase the
supply of personal computers causing their supply curve to shift to
the right. This has resulted in lowering the prices of personal
computers.
A personal computer which was available at price above Rs. 60,000
a few years ago are now available at about Rs. 20,000. Similarly, in
the Central Budget for 1993-94, the Finance Minister Dr.
Manmohan Singh reduced excise duties on several commodities
with the hope that producers it would pass it on to the consumers
and result in shifting their supply curve to the right and thereby
causing the drop in their prices. At lower prices, he argued, more of
these commodities would be demanded and therefore it would help
the industries which were facing demand recession.
by Taboola
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