• Social Scientist

Changes in Demand and Supply

Theme 2: Market, Demand and Supply

Topic: Changes in Demand and Supply

Relevance: H1 and H2 Economics

Introduction:

A market is where consumers and producers interact with their demand and supply to determine the market equilibrium price and quantity of a good or service exchanged. Changes in demand and supply will affect the allocation of resources in the free market as well as the market price and quantity of a good or service.


Demand of a good is the quantity of a good or services that consumer are willing and able to purchase at various prices in a given period of time, ceteris paribus.

Changes in demand is caused by changes in non-price determinants such as taste and preferences, disposable income, population, price of substitutes and complement and consumers' expectations of economic conditions and future prices will affect consumers’ willingness and ability to consume, therefore changing the demand for the good and cause the demand curve to shift.


Supply of a good is the quantity of a good that producers are willing and able to produce and offer for sale at various prices over a period of time, ceteris paribus.

Changes in supply is caused by a change in non-price determinants such as cost of production, prices of good in joint supply, prices of good in competitive in supply, technology and weather conditions will also affect producers’ willingness and ability to consume, therefore changing the supply for the good and cause the supply curve to shift.

Increase in Demand

Increase in demand can be caused by any one of the following changes:

  • Changing taste and preferences towards the good

  • Increase in disposable income (assuming normal good)

  • Decrease in disposable income (assuming inferior good)

  • Increase in population

  • Increase in price of substitutes

  • Decrease in price of complement

  • Improvement in consumers’ expectations of economic conditions

  • Consumers expecting future prices to be higher

These changes will cause consumers to be more willing and able to consume the goods leading to an increase in demand and the demand curve to shift right from DDOriginal to DDNew in Figure 1.

Figure 1: Increase in Demand

When demand increases, there will be a shortage at the original price P0 as quantity demanded is higher than quantity supplied. The shortage will lead to an upwards pressure on price as consumers will compete among themselves for the good and prices will increase until the new equilibrium. Therefore, as market equilibrium price increases from P0 to PN, market equilibrium quantity will increase from QO to QN.

Decrease in Demand

Decrease in demand can be caused by any one of the following changes:

  • Changing taste and preferences away from the good

  • Decrease in disposable income (assuming normal good)

  • Increase in disposable income (assuming inferior good)

  • Decrease in population

  • Decrease in price of substitutes

  • Increase in price of complement

  • Worsen consumers’ expectations of economic conditions

  • Consumers expecting future prices to be lower

These changes will cause consumers to be less willing and able to consume the goods leading to a decrease in demand and the demand curve to shift left from DDOriginal to DDNew in Figure 2.

Figure 2: Decrease in Demand

When demand decreases, there will be a surplus at the original price P0 as quantity demanded is lower than quantity supplied. The surplus will lead to a downwards pressure on price as producers will try to clear stock and reduce the surplus and prices will decrease until the new equilibrium. Therefore, as market equilibrium price decreases from P0 to PN, market equilibrium quantity will decrease from QO to QN.

Difference between changes in demand and quantity demanded

Changes in demand is caused by changes in factors other than the price of the good itself while changes in quantity demanded is only caused by changes the price of the good itself. Changes in demand will caused the demand curve to shift while changes in quantity demanded will not cause the demand curve but just a movement along the demand curve.

Increase in Supply

Increase in supply can be caused by any one of the following changes:

  • Decrease in cost of production

  • Increase in prices of good in joint supply

  • Decrease in prices of goods competitive in supply

  • Improvement in technology

  • Favourable weather conditions

  • Producers expecting future prices to be lower

These changes will cause producers to be more willing and able to consume the goods leading to an increase in supply and the supply curve to shift right from SSOriginal to SSNew in Figure 3.

Figure 3: Increase in Supply

When supply increases, there will be a surplus at the original price P0 as quantity demanded is lower than quantity supplied. The surplus will lead to a downwards pressure on price as producers will try to clear stock and reduce the surplus and prices will decrease until the new equilibrium. Therefore, as market equilibrium price decreases from P0 to PN, market equilibrium quantity will increase from QO to QN.

Decrease in Supply

Decrease in supply can be caused by any one of the following changes:

  • Increase in cost of production

  • Decrease in prices of good in joint supply

  • Increase in prices of goods competitive in supply

  • Unfavourable weather conditions

  • Producers expecting future prices to be higher

These changes will cause producers to be less willing and able to consume the goods leading to a decrease in supply and the supply curve to shift left from SSOriginal to SSNew in Figure 4.

Figure 4: Decrease in Supply

When supply decreases, there will be a shortage at the original price P0 as quantity demanded is higher than quantity supplied. The shortage will lead to an upwards pressure on price as consumers will compete among themselves for the good and prices will increase until the new equilibrium. Therefore, as market equilibrium price increases from P0 to PN, market equilibrium quantity will decrease from QO to QN.

Difference between changes in supply and quantity supplied

Changes in supply is caused by changes in factors other than the price of the good itself while changes in quantity supplied is only caused by changes the price of the good itself. Changes in supply will caused the supply curve to shift while changes in quantity supplied will not cause the supply curve but just a movement along the supply curve.

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