Effects of Changes in Demand and Supply on Market Equilibrium

Equilibrium Price and Equilibrium Quantity of a commodity is determined when the quantity demand is equal to the quantity of the commodity supplied. Therefore, if there is any change in the quantity demanded and/or quantity supplied of the commodity, there will be a shift in either the demand curve or supply curve or both, further resulting in a change in equilibrium price and equilibrium quantity. There are many factors that affect equilibrium price and equilibrium quantity. Factors other than the price of the product affect demand and supply in the form of movements in the curves. These movements cause a rightward or a leftward shift in demand and supply curves affecting equilibrium price and equilibrium quantity.

Some of the reasons responsible for a shift in the demand curve include Change in Population, Change in Price of Complementary Goods, Change in Price of Substitute Goods, Change in Income (Normal and Inferior Goods), Change in Taste and Preference, and Expectation of Change in the Price in Future. However, the reasons responsible for a shift in the supply curve include Change in Price of Factors of Production, Change in Price of other Goods, Change in the State of Technology, Change in the Taxation Policy, Expectations of Change in Price in Future, Change in the Goals of Firms, and Change in the Number of Firms.

1. Effects of Change in Demand

A shift in demand means an increase in demand or a decrease in demand. It occurs due to changes in determinants other than the own price of the commodity. For example, with an increase in income (other factors being constant), consumers will be able to buy more units of a product at the same price. This will cause a shift in demand, which will be indicated by a rightward shift in the demand curve. Similarly, with the decrease in income (other factors being constant), consumers will buy fewer units of any product at the same price. This will cause a shift in demand, which will be indicated by a leftward shift in the demand curve.

Case I – Increase in Demand

1. Here, the X-axis represents Quantity Demanded and Supplied, and the Y-axis represents Price. DD is the initial demand curve, SS is the supply curve and E is the initial equilibrium point on which P is the equilibrium price and Q is the equilibrium quantity.

2. Due to an increase in demand, the demand curve shifts from DD to D₁D₁, causing excess demand in the market, at the existing price.

3. Due to the pressure of demand, the price of the commodity tends to be higher than the equilibrium price. Thus, the price shifts from P to P₁.

4. Due to the rise in price from P to P₁, the quantity demanded tends to contract and the quantity supplied tends to expand. The expansion of supply and contraction of demand is continuous till excess demand is fully tackled.

5. E₁ is the point of new equilibrium where supply is once again equal to demand. Corresponding to the new equilibrium, the quantity demanded/supplied is OQ₁ and the equilibrium price is OP₁.

6. The net effect of an increase in demand is: (a) an increase in equilibrium price from OP to OP₁, and (b) an increase in equilibrium quantity from OQ to OQ₁.

Case II – Decrease in Demand

1. Here, the X-axis represents Quantity Demanded and Supplied, and the Y-axis represents Price. DD is the initial demand curve, SS is the supply curve and E is the initial equilibrium point on which P is the equilibrium price and Q is the equilibrium quantity.

2. Due to a decrease in demand, the demand curve shifts from DD to D₂D₂, causing a lack of demand in the market, at the existing price.

3. Due to the excess supply, the price of the commodity tends to be lower than the equilibrium price. Thus, the price shifts from P to P₂.

4. Due to a decline in price, the quantity demanded tends to expand and the quantity supplied tends to contract. The expansion of demand and contraction of supply is continuous till excess supply is fully tackled.

5. E₂ is the point of new equilibrium where supply is once again equal to demand. Corresponding to the new equilibrium, the quantity demanded/supplied is OQ₂ and the equilibrium price is OP₂.

6. The net effect of a decrease in demand is: (a) a decrease in equilibrium price from OP to OP₂, and (b) a decrease in equilibrium quantity from OQ to OQ₂.

2. Effects of Change in Supply

A shift in supply means an increase in supply or a decrease in supply. It occurs due to changes in determinants, other than the own price of the commodity. For example, supply increases when production cost falls leading to a fall in input price and supply decreases when production cost rises resulting in a rise in input price. This will cause a shift in supply, which will be indicated by a rightward or leftward shift in the supply curve.

Case I – Increase in Supply

1. Here, the X-axis represents Quantity Demanded and Supplied, and the Y-axis represents Price. DD is the initial demand curve, SS is the supply curve and E is the initial equilibrium point on which P is the equilibrium price and Q is the equilibrium quantity.

2. Due to an increase in supply, the supply curve shifts from SS to S₁S_1, causing an increase in supply in the market, at the existing price.

3. Due to the excess supply, the price of the commodity tends to be lower than the equilibrium price. Thus, the price shifts from P to P₁.

4. Due to a decline in price, the quantity demanded tends to expand and the quantity supplied tends to contract. The expansion of demand and contraction of supply is continuous till excess supply is fully tackled.

5. E₁ is the point of new equilibrium where supply is once again equal to demand. Corresponding to the new equilibrium, the quantity demanded/supplied is OQ₁ and the equilibrium price is OP₁.

6. The net effect of an increase in supply is: (a) a decrease in equilibrium price from OP to OP₁, and (b) an increase in equilibrium quantity from OQ to OQ₁.

Case II – Decrease in Supply

1. Here, the X-axis represents Quantity Demanded and Supplied, and the Y-axis represents Price. DD is the initial demand curve, SS is the supply curve and E is the initial equilibrium point on which P is the equilibrium price and Q is the equilibrium quantity.

2. Due to a decrease in supply, the supply curve shifts from SS to S₁S_1, causing an increase in demand, at the existing price.

3. Due to the excess demand and low supply, the price of the commodity tends to be higher than the equilibrium price. Thus, the price shifts from P to P₂.

4. Due to the rise in price, the quantity demanded tends to contract, and the quantity supplied tends to expand. The expansion of supply and contraction of demand is continuous till excess demand is fully tackled.

5. E₂ is the point of new equilibrium where supply is once again equal to demand. Corresponding to the new equilibrium, the quantity demanded/supplied is OQ₂ and the equilibrium price is OP₂.

6. The net effect of a decrease in supply is: (a) an increase in equilibrium price from OP to OP₂, and (b) a decrease in equilibrium quantity from OQ to OQ₂.

3. Effects of Simultaneous Change in Demand and Supply

Case I – Both Demand and Supply Decrease

(i) Decrease in Demand is equal to Decrease in Supply

Here, the X-axis represents Quantity Demanded and Supplied, and the Y-axis represents the Price. DD is the initial demand curve, SS is the supply curve and E is the initial equilibrium point on which P is the equilibrium price and Q is the equilibrium quantity. When the decrease in demand is proportionately equal to the decrease in supply, then the leftward shift in the demand curve from DD to D₁D₁ is proportionately equal to the leftward shift in the supply curve from SS to S₁S₁. The new equilibrium will be at E₁. The net effect of a simultaneous decrease in demand and decrease in supply, when a decrease in demand is equal to a decrease in supply, is (a) constant equilibrium price at P, and (b) a decrease in equilibrium quantity from OQ to OQ₁.

(ii) Decrease in Demand is greater than Decrease in Supply

Here, the X-axis represents Quantity Demanded and Supplied, and the Y-axis represents Price. DD is the initial demand curve, SS is the supply curve and E is the initial equilibrium point on which P is the equilibrium price and Q is the equilibrium quantity. When a decrease in demand is proportionately more than the decrease in supply, then the leftward shift in the demand curve from DD to D₁D₁ is proportionately more than the leftward shift in the supply curve from SS to S₁S₁. The new equilibrium will be at E₁. The net effect of the simultaneous decrease in demand and decrease in supply, when a decrease in demand is more than a decrease in supply is (a) a fall in equilibrium price from OP to OP₁, and (b) a decrease in equilibrium quantity from OQ to OQ₁.

(iii) Decrease in Demand is less than Decrease in Supply

Here, the X-axis represents Quantity Demanded and Supplied, and the Y-axis represents Price. DD is the initial demand curve, SS is the supply curve and E is the initial equilibrium point on which P is the equilibrium price and Q is the equilibrium quantity. When a decrease in demand is proportionately less than the decrease in supply, then the leftward shift in the demand curve from DD to D₁D₁ is proportionately less than the leftward shift in the supply curve from SS to S₁S₁. The new equilibrium will be at E₁. The net effect of a simultaneous decrease in demand and decrease in supply, when a decrease in demand is less than a decrease in supply is (a) a rise in equilibrium price from OP to OP₁, and (b) a decrease in equilibrium quantity from OQ to OQ₁.

Case II – Both Demand and Supply Increase

(i) Increase in Demand is equal to Increase in Supply

Here, the X-axis represents the Quantity Demanded and Supplied, and the Y-axis represents Price. DD is the initial demand curve, SS is the supply curve and E is the initial equilibrium point on which P is the equilibrium price and Q is the equilibrium quantity. When an increase in demand is proportionately equal to an increase in supply, then a rightward shift in the demand curve from DD to D₁D₁ is proportionately equal to a rightward shift in the supply curve from SS to S₁S₁. The new equilibrium will be at E₁. The net effect of the simultaneous increase in demand and increase in supply, when an increase in demand is equal to an increase in supply, is (a) the equilibrium price will remain the same, and (b) an increase in equilibrium quantity from OQ to OQ₁.

(ii) Increase in Demand is greater than Increase in Supply

Here, the X-axis represents the Quantity Demanded and Supplied, and the Y-axis represents Price. DD is the initial demand curve, SS is the supply curve and E is the initial equilibrium point on which P is the equilibrium price and Q is the equilibrium quantity. When an increase in demand is proportionately more than the increase in supply, then a rightward shift in the demand curve from DD to D₁D₁ is proportionately more than a rightward shift in the supply curve from SS to S₁S₁. The new equilibrium will be at E₁. The net effect of the simultaneous increase in demand and increase in supply, when an increase in demand is more than the increase in supply, is (a) a rise in equilibrium price from OP to OP₁, and (b) an increase in equilibrium quantity from OQ to OQ₁.

(iii) Increase in Demand is less than Increase in Supply

Here, the X-axis represents Quantity Demanded and Supplied, and the Y-axis represents the Price. DD is the initial demand curve, SS is the supply curve and E is the initial equilibrium point on which P is the equilibrium price and Q is the equilibrium quantity. When an increase in demand is proportionately less than the increase in supply, then a rightward shift in the demand curve from DD to D₁D₁ is proportionately less than a rightward shift in the supply curve from SS to S₁S₁. The new equilibrium will be at E₁. The net effect of the simultaneous increase in demand and increase in supply, when an increase in demand is less than the increase in supply, is (a) a fall in equilibrium price from OP to OP₁, and (b) an increase in equilibrium quantity from OQ to OQ₁.

Case III – Demand Decreases and Supply Increases

(i) Decrease in Demand is equal to Increase in Supply

Here, the X-axis represents Quantity Demanded and Supplied, and the Y-axis represents the Price. DD is the initial demand curve, SS is the supply curve and E is the initial equilibrium point on which P is the equilibrium price and Q is the equilibrium quantity. When a decrease in demand is proportionately equal to an increase in supply, then a leftward shift in the demand curve from DD to D₁D₁ is proportionately equal to a rightward shift in the supply curve from SS to S₁S₁. The new equilibrium will be at E₁. The net effect of a simultaneous decrease in demand and increase in supply, when a decrease in demand is equal to an increase in supply, is (a) equilibrium quantity remains the same, and (b) a decrease in equilibrium price from OP to OP₁.

(ii) Decrease in Demand is greater than Increase in Supply

Here, the X-axis represents Quantity Demanded and Supplied, and the Y-axis represents the Price. DD is the initial demand curve, SS is the supply curve and E is the initial equilibrium point on which P is the equilibrium price and Q is the equilibrium quantity. When a decrease in demand is proportionately more than an increase in supply, then a leftward shift in the demand curve from DD to D₁D₁ is proportionately more than a rightward shift in the supply curve from SS to S₁S₁. The new equilibrium will be at E₁. The net effect of a simultaneous decrease in demand and increase in supply, when a decrease in demand is less than an increase in supply, is (a) a fall in equilibrium quantity from OQ to OQ₁, and (b) a fall in equilibrium price from OP to OP₁.

(ii) Decrease in Demand is less than Increase in Supply

Here, the X-axis represents Quantity Demanded and Supplied, and the Y-axis represents the Price. DD is the initial demand curve, SS is the supply curve and E is the initial equilibrium point on which P is the equilibrium price and Q is the equilibrium quantity. When a decrease in demand is proportionately less than an increase in supply, then a leftward shift in the demand curve from DD to D₁D₁ is proportionately less than a rightward shift in the supply curve from SS to S₁S₁. The new equilibrium will be at E₁. The net effect of a simultaneous decrease in demand and increase in supply, when a decrease in demand is less than an increase in supply, is (a) a rise in equilibrium quantity from OQ to OQ₁, and (b) a fall in equilibrium price from OP to OP₁.

Case IV – Demand Increases and Supply Decreases

(i) Increase in Demand is equal to Decrease in Supply

Here, the X-axis represents Quantity Demanded and Supplied, and the Y-axis represents the Price. DD is the initial demand curve, SS is the supply curve and E is the initial equilibrium point on which P is the equilibrium price and Q is the equilibrium quantity. When an increase in demand is proportionately equal to a decrease in supply, then a rightward shift in the demand curve from DD to D₁D₁ is proportionately equal to a leftward shift in the supply curve from SS to S₁S₁. The new equilibrium will be at E₁. The net effect of a simultaneous increase in demand and decrease in supply, when an increase in demand is equal to a decrease in supply, is (a) Equilibrium quantity remains the same, and (b) an increase in equilibrium price from OP to OP₁.

(ii) Increase in Demand is greater than Decrease in Supply

Here, the X-axis represents Quantity Demanded and Supplied, and the Y-axis represents the Price. DD is the initial demand curve, SS is the supply curve and E is the initial equilibrium point on which P is the equilibrium price and Q is the equilibrium quantity. When an increase in demand is proportionately more than a decrease in supply, then a rightward shift in the demand curve from DD to D₁D₁ is proportionately more than a leftward shift in the supply curve from SS to S₁S₁. The new equilibrium will be at E₁. The net effect of a simultaneous increase in demand and decrease in supply, when an increase in demand is more than a decrease in supply, is (a) a rise in equilibrium quantity from OQ to OQ₁, and (b) an increase in equilibrium price from OP to OP₁.

(iii) Increase in Demand is less than Decrease in Supply

Here, the X-axis represents Quantity Demanded and Supplied, and the Y-axis represents the Price. DD is the initial demand curve, SS is the supply curve and E is the initial equilibrium point on which P is the equilibrium price and Q is the equilibrium quantity. When an increase in demand is proportionately less than a decrease in supply, then a rightward shift in the demand curve from DD to D₁D₁ is proportionately less than a leftward shift in the supply curve from SS to S₁S₁. The new equilibrium will be at E₁. The net effect of a simultaneous increase in demand and decrease in supply, when an increase in demand is less than a decrease in supply, is (a) a fall in equilibrium quantity from OQ to OQ₁, and (b) an increase in equilibrium price from OP to OP₁.

4. Special Cases

Case 1 – When Supply is Perfectly Elastic

When the supply curve is perfectly elastic; i.e., the supply curve is parallel to the X-axis, an increase or a decrease in demand does not cause any effect on the equilibrium price. Only the equilibrium quantity tends to change.

(i) Increase in Demand

Here, the X-axis represents Quantity Demanded and Supplied, and the Y-axis represents the Price. DD is the initial demand curve, SS is the supply curve and E is the initial equilibrium point on which P is the equilibrium price and Q is the equilibrium quantity. With an increase in demand; i.e., a rightward shift in the demand curve from DD to D₁D₁, the equilibrium price remains unchanged at OP and the equilibrium quantity rises from OQ to OQ₁. E₁ will be the new equilibrium.

(ii) Decrease in Demand

Here, the X-axis represents Quantity Demanded and Supplied, and the Y-axis represents the Price. DD is the initial demand curve, SS is the supply curve and E is the initial equilibrium point on which P is the equilibrium price and Q is the equilibrium quantity. With a decrease in demand; i.e., a leftward shift in the demand curve from DD to D₂D₂, the equilibrium price remains unchanged at OP and the equilibrium quantity falls from OQ to OQ₂. E₂ will be the new equilibrium.

Case 2 – When Supply is Perfectly Inelastic

When the supply curve is perfectly inelastic; i.e., the supply curve is parallel to the Y-axis, an increase or a decrease in demand does not cause any effect on the equilibrium quantity. Only the equilibrium price tends to change.

(i) Increase in Demand

Here, the X-axis represents Quantity Demanded and Supplied, and the Y-axis represents the Price. DD is the initial demand curve, SS is the supply curve and E is the initial equilibrium point on which P is the equilibrium price and Q is the equilibrium quantity. With an increase in demand; i.e., a rightward shift in the demand curve from DD to D₁D₁, the equilibrium quantity remains unchanged at OQ and the equilibrium price rises from OP to OP₁. E₁ will be the new equilibrium.

(ii) Decrease in Demand

Here, the X-axis represents Quantity Demanded and Supplied, and the Y-axis represents the Price. DD is the initial demand curve, SS is the supply curve and E is the initial equilibrium point on which P is the equilibrium price and Q is the equilibrium quantity. With a decrease in demand; i.e., a leftward shift in the demand curve DD to D₂D₂, the equilibrium quantity remains unchanged at OQ and the equilibrium price falls from OP to OP₂. E₂ will be the new equilibrium.

Case 3 – When Demand is Perfectly Elastic

When the demand curve is perfectly elastic; i.e., demand curve is parallel to the X-axis, an increase or a decrease in supply does not cause any effect on the equilibrium price. Only the equilibrium quantity tends to change.

(i) Increase in Supply

Here, the X-axis represents Quantity Demanded and Supplied, and the Y-axis represents the Price. DD is the initial demand curve, SS is the supply curve and E is the initial equilibrium point on which P is the equilibrium price and Q is the equilibrium quantity. With an increase in supply; i.e., a rightward shift in the supply curve from SS to S₁S₁, the equilibrium price remains unchanged at OP and the equilibrium quantity rises from OQ to OQ₁. E₁ will be the new equilibrium.

(ii) Decrease in Supply

Here, the X-axis represents Quantity Demanded and Supplied, and the Y-axis represents the Price. DD is the initial demand curve, SS is the supply curve and E is the initial equilibrium point on which P is the equilibrium price and Q is the equilibrium quantity. With a decrease in supply; i.e., a leftward shift in the supply curve from SS to S₂S₂, the equilibrium price remains unchanged at OP and the equilibrium quantity falls from OQ to OQ₂. E₂ will be the new equilibrium.

Case 4 – When Demand is Perfectly Inelastic

When the demand curve is perfectly inelastic; i.e., the demand curve is parallel to the Y-axis, an increase or a decrease in supply does not cause any effect on the equilibrium quantity. Only the equilibrium price tends to change.

(i) Increase in Supply

Here, the X-axis represents Quantity Demanded and Supplied, and the Y-axis represents the Price. DD is the initial demand curve, SS is the supply curve and E is the initial equilibrium point on which P is the equilibrium price and Q is the equilibrium quantity. With an increase in supply; i.e., a rightward shift in the supply curve from SS to S₁S₁, the equilibrium quantity remains unchanged at OQ and the equilibrium price falls from OP to OP₁. E₁ will be the new equilibrium.

(ii) Decrease in Supply

Here, the X-axis represents Quantity Demanded and Supplied, and the Y-axis represents the Price. DD is the initial demand curve, SS is the supply curve and E is the initial equilibrium point on which P is the equilibrium price and Q is the equilibrium quantity. With a decrease in supply; i.e., a leftward shift in the supply curve from SS to S₂S₂, the equilibrium quantity remains unchanged at OQ and the equilibrium price rises from OP to OP₂. E₂ will be the new equilibrium.