Question

Market for a good is in equilibrium. There is simultaneous "decrease" both in demand and supply of the good. Explain its effect on market price

A market for a good is in equilibrium. The demand for the good 'decreases'. Explain the chain of effects of this change

Answer 1

When there is simultaneous decrease in demand and supply, the equilibrium point of price of output will depend on the basis of proportion of changes in demand and supply. Let us understand the effects through the following conditions.
i. If decrease in demand is equal to decrease in supply
When the demand decreases from D₁D₁ to D₂D₂ and the supply decreases from S₁S₁ to S₂S₂ in the same proportion, the new equilibrium price will be OP₁ and the new equilibrium output will be OQ₂. This new price and output intersect each other at Point E₂ and will arrive at new equilibrium. As the decrease in demand is equal to the decrease in supply, the price remains the same and the quantity will decrease at the new equilibrium point.

ii. If decrease in demand is more than decrease in supply
When the demand decreases, the demand curve will shift to D₂D₂ and the decrease in supply will shift the supply curve to S₂S₂. Here, the decrease in demand is more than the supply; hence, there will be a new equilibrium price and a new equilibrium output which intersects at Point E₂. As the decrease in demand is more than the decrease in supply, the equilibrium price decreases and the equilibrium quantity level decreases at the new equilibrium point.

iii. If decrease in demand is less than decrease in supply
When the demand decreases, the demand curve will shift to D₂D₂ and the decrease in supply will shift the supply curve to S₂S₂. Here, the decrease in demand is less than the supply; hence, there will be a new equilibrium price and a new equilibrium output which intersects at Point E₂. As the decrease in demand is less than the decrease in supply, the equilibrium price increases and the equilibrium output decreases at the new equilibrium point.

Answer 2

Consider DD₁ to be the initial demand curve and SS to be the supply curve of the market. Market equilibrium is achieved at Point E, where the demand and supply curves intersect each other. Therefore, the equilibrium price is OP₁, and the equilibrium quantity demanded is OQ₁.

If there is fall in the demand, the demand curve will shift towards the left to DD1 and the supply curve SS will remain the same. This implies that at the initial price OP₁, there is an excess supply of OQ₁ to OQ¹₁ units of output. Thereby the competition among producers will increase and they tend to reduce the price of the output to the OP₂ level. Now, the new
market equilibrium will be at Point E₁, where the new demand curve DD₁ intersects the supply curve S

This clearly states that if the demand curve shifts towards the left, the price of the good tends to decrease with the decrease in the demand for a good. Thus, the direction of change in equilibrium price and the quantity are the same whenever there is a shift in the demand
curve