3.3 Changes in Equilibrium Price and Quantity: The Four-Step Process

Markets are like a dance between buyers and sellers. Demand and supply curves show how much people want to buy or sell at different prices. When these curves meet, we find the sweet spot where everyone's happy.

Changes in factors like income or technology can shift these curves. This leads to new equilibrium prices and quantities. Understanding these shifts helps us predict how markets will react to real-world events.

Equilibrium Price and Quantity

Four-step process for market equilibrium

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• Step 1: Determine the demand curve
  • Plot the demand curve on a graph with price on the y-axis and quantity on the x-axis
  • Demand curve shows the inverse relationship between price and quantity demanded, holding all other factors constant (ceteris paribus)
  • Example: As the price of a good increases, the quantity demanded by consumers decreases
• Step 2: Determine the supply curve
  • Plot the supply curve on the same graph as the demand curve
  • Supply curve shows the positive relationship between price and quantity supplied, holding all other factors constant (ceteris paribus)
  • Example: As the price of a good increases, producers are willing to supply more of the good to the market
• Step 3: Find the equilibrium point
  • Equilibrium occurs at the intersection of the demand and supply curves
  • At this point, the quantity demanded by consumers equals the quantity supplied by producers
  • Example: The market for a particular good is in equilibrium when the price is $10 and the quantity is 100 units
• Step 4: Identify the equilibrium price and quantity
  • The equilibrium price is the price coordinate of the equilibrium point ($10 in the example)
  • The equilibrium quantity is the quantity coordinate of the equilibrium point (100 units in the example)
  • This equilibrium represents the market forces at work, balancing supply and demand

Graphical effects of demand and supply changes

• Changes in demand
  • Increase in demand: Demand curve shifts to the right, resulting in a higher equilibrium price and quantity (more demand at each price)
    • Example: An increase in consumer income leads to higher demand for normal goods (cars)
  • Decrease in demand: Demand curve shifts to the left, resulting in a lower equilibrium price and quantity (less demand at each price)
    • Example: A change in consumer preferences away from a particular good (CDs) reduces demand
• Changes in supply
  • Increase in supply: Supply curve shifts to the right, resulting in a lower equilibrium price and higher equilibrium quantity (more supply at each price)
    • Example: Technological advancements in production processes increase the supply of a good (smartphones)
  • Decrease in supply: Supply curve shifts to the left, resulting in a higher equilibrium price and lower equilibrium quantity (less supply at each price)
    • Example: An increase in input prices (labor costs) reduces the supply of a good (restaurant meals)

Shifts vs movements along curves

• Shifts of demand or supply curves
  • Occur when a factor other than price changes, causing the entire curve to shift to a new position
  • Factors affecting demand: income, preferences, prices of related goods (substitutes and complements), expectations, and number of buyers
    • Example: An increase in the price of a substitute good (tea) shifts the demand curve for coffee to the right
  • Factors affecting supply: input prices, technology, expectations, number of sellers, and government policies (taxes and subsidies)
    • Example: A subsidy for solar panel production shifts the supply curve for solar panels to the right
• Movements along demand or supply curves
  • Occur when a change in price causes a change in the quantity demanded or supplied, moving along the existing curve
  • Movement along the demand curve: A change in price leads to a change in quantity demanded, as indicated by the existing demand curve
    • Example: An increase in the price of apples leads to a decrease in the quantity of apples demanded, moving along the demand curve
  • Movement along the supply curve: A change in price leads to a change in quantity supplied, as indicated by the existing supply curve
    • Example: An increase in the price of oil leads to an increase in the quantity of oil supplied, moving along the supply curve

Market Efficiency and Equilibrium

• The price mechanism helps allocate resources efficiently in a market economy
• Economic efficiency is achieved when the market reaches equilibrium
• Allocative efficiency occurs when resources are distributed optimally to maximize social welfare
• Dynamic equilibrium refers to the constant adjustments in the market as conditions change
• Comparative statics analysis compares different equilibrium states to understand market changes

Applying Demand and Supply Analysis

Analysis of real-world market scenarios

1. Identify the relevant factors affecting demand and supply in the market
   • Example: In the market for electric vehicles, relevant factors may include consumer preferences, fuel prices, government incentives, and production costs
2. Determine the initial equilibrium price and quantity using the four-step process
   • Example: The initial equilibrium price for electric vehicles is $30,000, and the equilibrium quantity is 100,000 units
3. Analyze the impact of changes in demand or supply factors on the equilibrium
   • Shift the appropriate curve (demand or supply) based on the change in the relevant factor
     • Example: An increase in government incentives for electric vehicle purchases shifts the demand curve to the right
   • Find the new equilibrium point and compare it to the initial equilibrium
     • Example: The new equilibrium price is $32,000, and the new equilibrium quantity is 120,000 units
4. Interpret the results
   • Explain how the change in the factor affects the equilibrium price and quantity
     • Example: The increase in government incentives leads to higher demand for electric vehicles, resulting in a higher equilibrium price and quantity
   • Discuss the implications for consumers, producers, and the market as a whole
     • Example: Consumers who purchase electric vehicles benefit from the incentives but face higher prices, while producers experience increased sales and potentially higher profits