DEMAND AND SUPPLY

Demand and Supply

Demand and Supply

Introduction

The law of demand suggests that an inverse mathematical relationship exists between price and quantity demanded. The law of supply suggests that a similar but positive relationship exists between price and quantity supplied.

Discussion

The Effects of a Change in Demand

The impact on equilibrium price and quantity of a change in demand is illustrated in below mentioned Figure A.

Fiqure A

Figure A represents the market for gasoline. Assume the market is initially in equilibrium at point E 1. Further assume that national income statistics indicate an increase in household income, ceteris paribus. What impact would this increase in income have on the equilibrium price and quantity in the market for gasoline? At the original equilibrium price of P 1, consumers are now willing and able to purchase more gasoline even though the price of gasoline initially remains unchanged. In Figure A, this is represented by a movement from point E 1 to A, and an increase in quantity from Q 1 to Q 3. At the initial price of P 1, this increase in demand causes a shortage of (Q 3 - Q 1). The increasing price causes a decrease in quantity demanded along the new demand curve, D 2, and an increase in quantity supplied along the supply curve. When all of these factors are combined, the market moves toward a higher equilibrium price and quantity at P 2 and Q 2.

Figure: Effects of a Change in Demand

NOTE: An increase, in demand results in an increase in equilibrium price and an increase in quantity supplied from Q 1 to Q 2.

The Effects of a Change in Supply

Assume the number of seller's increases, ceteris paribus (see below mentioned Figure B).

Fiqure B

The shift from S 1 to S 2 represents the increase in supply resulting from an increase in the amount of sellers who are willing and able to provide gasoline at every price. At the original equilibrium, price P 1, this increase in supply results in a surplus equal (Q 3 - Q 1). As sellers reduce the price and production to reduce the surplus in the market, buyers increase their quantity demanded in response to the lower price.

Figure: The Effects of a Change in Supply

NOTE: An increase, in supply results in a decrease in equilibrium price, and an increase in quantity demanded from Q 1 to Q 2.

This change in equilibrium price and quantity verifies the graphical predictions that an increase in supply will result in a decrease in equilibrium price and an increase in equilibrium quantity. In this case, the equilibrium price has decreased from 260 to 255, and the equilibrium quantity has increased from 25,000 to 25,100.

What would be the impact on equilibrium price and quantity if supply and demand both increased simultaneously?

In such cases, the individual effects are combined. Because the increases in both supply and demand result in increases in the equilibrium quantities, the combined result will be an increase, in equilibrium quantity. However, the result on equilibrium price is ...