MODULE 7 Supply and Demand: Changes in Equilibrium Krugman/Wells

How equilibrium price and quantity are affected when there is a change in either supply or demand How equilibrium price and quantity are affected when there is a simultaneous change in both supply and demand

Equilibrium and Shifts of the Demand Curve Price of coffee beans An increase in demand… Supply … leads to a movement along the supply curve due to a higher equilibrium price and higher equilibrium quantity. E 2 P 2 Price rises E 1 P 1 Figure Caption: Figure 7.1: Equilibrium and Shifts of the Demand Curve The original equilibrium in the market for coffee is at E1, at the intersection of the supply curve and the original demand curve, D1. A rise in the price of tea, a substitute, shifts the demand curve rightward to D2. A shortage exists at the original price, P1, causing both the price and quantity supplied to rise, a movement along the supply curve. A new equilibrium is reached at E2, with a higher equilibrium price, P2, and a higher equilibrium quantity, Q2. When demand for a good or service increases, the equilibrium price and the equilibrium quantity of the good or service both rise. Note to the instructor: An example from sports: The recent successes of the Red Sox (Boston’s Baseball Team) caused an increase in demand for the tickets of Red Socks games. In 10 years, global warming may increase the demand for land in parts of the world earlier considered “too cold.” Question for Class Discussion: Coffee and tea are substitutes: if the price of tea rises (falls), the demand for coffee will increase (decrease). But how does the price of tea affect the market for coffee? D 2 D 1 Q Q 1 2 Quantity of coffee beans

Equilibrium and Shifts of the Supply Curve Price of coffee beans S S A decrease in supply… 2 1 E P 2 2 … leads to a movement along the demand curve due to a higher equilibrium price and lower equilibrium quantity. Price rises P E 1 1 A drought causes a fall in the supply of coffee beans. How does this negative supply shock affect the market for coffee? Figure Caption: Figure 7.2: Equilibrium and Shifts of the Supply Curve The original equilibrium in the market for coffee beans is at E1. A drought causes a fall in the supply of coffee beans and shifts the supply curve leftward from S1 to S2. A new equilibrium is established at E2, with a higher equilibrium price, P2, and a lower equilibrium quantity, Q2. Note to the instructor: An example from sports: The recent successes of Red Socks (Boston’s Baseball Team) caused an increase in demand for the tickets of Red Socks games. In 10 years, global warming may increase the demand for land in parts of the world earlier considered “too cold.” Demand Q Q Quantity of coffee beans 2 1 Quantity falls

Simultaneous Shifts of Supply and Demand Curves (a) One possible outcome: Price Rises, Quantity Rises Price of coffee Small decrease in supply S S 2 1 Two opposing forces determining the equilibrium quantity. E The increase in demand dominates the decrease in supply. 2 P 2 Figure Caption: Figure 7.3 (a) There is a simultaneous rightward shift of the demand curve and leftward shift of the supply curve. Here the increase in demand is relatively larger than the decrease in supply, so the equilibrium price and equilibrium quantity both rise. E 1 P 1 D 2 D 1 Large increase in demand Q Quantity of coffee 1 Q 2

Simultaneous Shifts of Supply and Demand Curves (b) Another Possibility Outcome: Price Rises, Quantity Falls Price of coffee Two opposing forces determining the equilibrium quantity. Large decrease in supply S 2 S 1 E 2 P 2 E Small increase in demand Figure Caption: Figure 7.3 (b) There is also a simultaneous rightward shift of the demand curve and leftward shift of the supply curve. Here the decrease in supply is relatively larger than the increase in demand, so the equilibrium price rises and the equilibrium quantity falls. 1 P 1 D 2 D 1 Q Q Quantity of coffee

The Great Tortilla Crises There was a sharp rise in the price of tortillas in early 2007, a staple food of Mexico’s poor, going from 25 cents a pound to between 35 and 45 cents a pound in just a few months. Much of Mexico’s corn is imported from the United States. U.S. corn prices were rising rapidly thanks to surging demand in a new market: the market for ethanol.

Simultaneous Shifts of Supply and Demand Supply Increases Supply Decreases Demand Increases Price: ambiguous Quantity: up Price: up Quantity: ambiguous Demand Decreases Price: down Quantity: down