In a recent post, I introduced the concepts of supply and demand. I will take these concepts a little further now.
The supply and demand curves that we plotted showed the relationship between the price and quantity of a commodity. However there are a lot of other factors that will affect the supply and demand of a commodity – and we have assumed that these have been kept constant* when plotting our curves.
In other words, the supply and demand diagram is a snapshot in time. If we take the market for apples as an example, it assumes that there is a certain number of people buying and selling apples, and they have a certain amount of money, and all else, whether the weather or taxes or apple-growing techniques, is the same.
But this can’t last long. More people are born, and they want more apples. People get richer, and choose to buy more apples. The government cuts taxes on orchards, so they grow more apples. There’s a spell of bad weather, less apples are grown etc.
The way to think of this is to see how the supply and demand curves are shifted**:
An increase in demand
If people’s incomes rise***, they will buy more apples at each price. The demand curve will shift to the right:
If the supply of apples hasn’t changed, then the price and quantity of apples will be higher than before. We can see that the new equilibrium E’ at a higher price and higher quantity than the old equilibrium E.
An increase in demand increases price and increases quantity.
A decrease in demand
If, on the other hand, people’s income go down, then they will buy less apples, and the demand curve will shift to the left:
If the supply of apples hasn’t changed, then the price and quantity of apples will be lower than before.
A decrease in demand decreases price and decreases quantity.
An increase in supply
If there’s particularly good weather for a season****, then more apples will be grown, and the supply curve will shift to the right:
If the demand for apples hasn’t changed, then the price of apples will fall, and the quantity bought will rise.
An increase in supply decreases price and increases quantity.
A decrease in supply
If the government suddenly slapped a big tax on apple growing, less apples will be grown, and the supply curve will shift to the left:
If the demand for apples hasn’t changed, then the price of apples will rise, and the quantity bought will fall.
A decrease in supply increases price and decreases quantity.
* Ceteris Paribus: As Latin makes everything sound more intelligent, we say that a supply or demand curve shows the relationship of price to quantity, ceteris paribus – which means “with other things the same,” or “all other things being equal or held constant.”
Whenever we want to find the relationship between two things, we must keep all other things the same. If you wanted to find out how much weight you put on from eating twice as much as usual, you’d wouldn’t want to double the amount of exercise you did at the same time. How could you disentangle the effects of overeating from those of exercising?
** Movement along vs. Shifts of: It is very important to distinguish in economics between movements along a curve and the shift of a curve.
With a single supply or demand curve, we are showing the relationship between two variables – price and quantity – all else equal. If we change the price, then we move along the curve to find the new quantity that will be demanded or supplied. The curve stays where it is, we just move to a different point along it.
The moment we change something other than price that changes quantities demanded or supplied, then we shift the entire curve.
Comparative Statics: The method used here reoccurs a lot in economics. We draw a couple of curves which represent certain relationships between variables. We then see where the two curves cross, to find an equilibrium.
A change causes one or both of the curves to shift, and a new equilibrium is found. We then compare the new and old equilibria to see how the variables we are interested in have changed.
This is the method of comparative statics.
*** What causes the demand curve to shift? Other things that might shift the demand curve to the right might be a growing population, a successful apple marketing campaign, or increases in the prices of oranges and lemons.
To figure out what might shift the demand curve to the left, just reverse the reasoning… lower incomes, a shrinking population etc.
Generally, demand is affected by: population, average incomes, prices of related goods, tastes and special influences.
**** What causes the supply curve to shift? Other things that can increase supply might be: better fertilisers and chemicals to grow apples, and better machinery to collect them, lower wages of apple pickers or prices of apple trees, less taxes on and regulation of orchards or a fall in the price of oranges and lemons.
The reverse reasoning will show what shifts supply to the left.
Generally, supply is affected by: technology, input prices, prices of related goods, government policy and special influences.
***** If you struggle with these, just make an ‘X’ with your arms, remembering your right arm is the demand curve and your left arm the supply curve. Move one arm or the other to the left or right, and notice whether the point where your arms cross is further up/down and left/right than before. Here’s a picture of Dannii Minogue figuring out how shifts of curves affect equilibrium price and quantities: