Market Dynamics: Factors Shaping Prices and Quantities

Examination of  market equilibrium assumes that consumer preferences, prices of related goods, consumer incomes, technology, market size, input prices, and more remain unchanged.

However, alterations in these factors can lead to shifts in either the supply curve, the Shift in Demand Curve, or both, consequently influencing equilibrium price and quantity.

Shift in Demand Curve: Impact on Price and Quantity in Markets

• As shown in Figure, illustrating the impact of a demand shift in a fixed number of firms. 
• Initially, the equilibrium point is E, where the market demand curve DD0 intersects the market supply curve SS0, resulting in equilibrium quantity q0 and price p0.
• Right Shift of Demand Curve: Suppose the market demand curve shifts to the right, becoming DD2 while the supply curve remains SS0.
  • This shift indicates increased quantity demanded at any price. 
  • Consequently, at price p0, there is excess demand equal to q0q0”.
  • To address this excess demand, some individuals are willing to pay higher prices, leading to a price increase.
  • The new equilibrium is at point G, with quantity q2 greater than q0 and price p2 greater than p0.
• Leftward Shift in Demand Curve: Conversely, if the Shift in Demand Curve leftward to DD1,
  • The quantity demanded at any price is now lower than before.
  • Thus, at the initial equilibrium price p0 there is excess supply equal to q0’q0.
  • In response, some firms lower their prices to sell their desired quantity.
  • The new equilibrium is at point F, where the demand curve DD1 intersects the supply curve SS0, resulting in a lower price p1 and quantity q1 compared to the initial values.
• The direction of change in equilibrium price and quantity is the same when there’s a Shift in Demand Curve.

Having established the general theory, let’s examine how changes in specific factors affect the Shift in Demand Curve, equilibrium quantity, and price. 

Changes in specific factors affecting demand curve, equilibrium quantity, and price

Increase in Consumers’ Income: Impact on Goods and Prices

• When consumers’ incomes rise, they can spend more on certain goods.
• For normal goods (like clothes), an increase in income typically leads to increased demand, assuming constant prices and consumer preferences.
• This increase of Shift in Demand Curves the market demand curve rightward.
• However, the supply curve remains unaffected by changes in consumer income, as it primarily shifts due to factors related to technology or production costs.
• In Figure, this is illustrated by the shift of the demand curve from DD0 to DD2, while the supply curve (SS0) remains unchanged.
• Consequently, the new equilibrium point (G) shows higher prices and greater quantities of clothes demanded and sold.

Increase in Consumers Spurs Demand: Shift in Demand Curve

• If the number of consumers in the market for clothes increases, and other factors remain constant, the demand for clothes rises at each price level.
• This increase in demand causes a rightward shift in demand curve.
• However, the supply curve remains unaffected by changes in the number of consumers; it typically shifts due to factors related to firms’ behavior or changes in the number of firms.
• Again, the Shift in Demand Curve from DD0 to DD2, while the supply curve (SS0) remains unchanged. 
• This leads to a new equilibrium point (G), where both price and quantity demanded and supplied increase compared to the previous equilibrium point (E).

Supply Shift in Demand Curve: Impact on Price and Quantity Dynamics

• Supply Curve Shifts Leftward: Now, consider the scenario where, due to certain factors, the market supply curve shifts leftward to SS2 while keeping the Shift in Demand Curve unchanged.
  • This shift results in excess demand at the current price p0, equal to q0“q0.

• Some consumers, unable to obtain the goods, are willing to pay more, driving the market price upward.
• The new equilibrium is established at point G, where the supply curve SS2 intersects the demand curve DD0.
• This leads to a higher price p2 and a lower quantity q2 bought and sold.
• Supply Curve Shifts Rightward: Conversely, there will be an excess supply at the current price p0, equal to q0q0‘.
  • In response, some firms lower their prices, leading to a new equilibrium at point F, where the supply curve SS1 intersects the demand curve DD0.
  • This results in a lower price p1 and a higher quantity q1 bought and sold.
• Note that the directions of price and quantity changes are opposite when there is a shift in the supply curve.

Now, let’s analyze the effects of increase in input price and increase in number of firms in the market:

Changes in specific factors affecting supply curve, equilibrium quantity, and price:

Increase in Input Price:

• If the price of an input used in production rises while all other factors remain constant, the marginal cost of production for firms using this input increases.
• Supply Curve Shift Leftward: Consequently, at each price level, the market supply decreases, shifting the supply curve leftward.
  • In Figure , this is depicted as a shift from SS0 to SS2. 
  • However, this increase in input price does not directly affect consumer demand (represented by the unchanged DD0 curve).
• The outcome is an increase in market price and a decrease in the quantity produced compared to the previous equilibrium.

Increase in the Number of Firms:

• Supply Curve Shifts Rightward: When more firms enter the market, the supply curve shifts rightward because there are more suppliers at each price level.
  • However, this change does not impact consumer demand (again represented by the unchanged DD0 curve).
  • In Figure , this is illustrated by the supply curve shifting from SS0 to SS1.
• Consequently, there will be a decrease in the price of the commodity and an increase in the quantity produced compared to the initial situation.

Simultaneous Shift in Demand Curve and Supply: Equilibrium Dynamics

Simultaneous shifts in both supply and Shift in Demand Curve can occur in four possible ways:

1. Both supply and demand curves shift rightwards.
2. Both supply and demand curves shift leftwards.
3. The supply curve shifts leftward, and the demand curve shifts rightward.
4. The supply curve shifts rightward, and the demand curve shifts leftward.

Impact of Simultaneous Shifts on Equilibrium

• The impact on equilibrium price and quantity for each of these scenarios is shown in Figure.
• Each row in the table outlines the expected direction of change in equilibrium price and quantity for a given combination of shifts in the supply and Shift in Demand Curve.
• For instance, in the second row of the table, when both supply and Shift in Demand Curve rightwards, 
  • The equilibrium quantity invariably increases.
• However, the equilibrium price may either increase, decrease, or remain unchanged, depending on the magnitudes of the shifts.
• As shown in the first two rows, the impact on equilibrium quantity is clear, but the equilibrium price may change in either direction depending on the magnitude of the shifts.
• In the next two cases (shown in the last two rows), the effect on price is clear, while the effect on quantity depends on the magnitude of shifts in the two curves.

• In Figure (left), we depict the scenario where both the demand and supply curves shift rightward simultaneously. 
• • The equilibrium quantity increases, but the equilibrium price remains the same.
• In Figure (right), we illustrate a situation where the demand curve shifts leftward, and the supply curve shifts rightward simultaneously.
  • In this case, the equilibrium quantity remains the same, but the equilibrium price decreases.