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### Course: Microeconomics>Unit 2

Lesson 3: Market equilibrium and changes in equilibrium

# Changes in equilibrium price and quantity: the four-step process

Let's look at some step-by-step examples of shifting supply and demand curves.

## Key points

• There is a four-step process that allows us to predict how an event will affect the equilibrium price and quantity using the supply and demand framework.
• Step one: draw a market model (a supply curve and a demand curve) representing the situation before the economic event took place.
• Step two: determine whether the economic event being analyzed affects demand or supply.
• Step three: decide whether the effect on demand or supply causes the curve to increase (shift to the right) or decrease (shift to the left) and to sketch the new demand or supply curve on the diagram.
• Step four: identify the new equilibrium price and quantity and then compare the original equilibrium price and quantity to the new equilibrium price and quantity.

## Changes in equilibrium price and quantity: the four-step process

Let's start thinking about changes in equilibrium price and quantity by imagining a single event has happened. It might be an event that affects demand—like a change in income, population, tastes, prices of substitutes or complements, or expectations about future prices. Or, it might be an event that affects supply—like a change in natural conditions, input prices, technology, or government policies that affect production.
How do we know how an economic event will affect equilibrium price and quantity? Luckily, there's a four-step process that can help us figure it out!
Step 1. Draw a demand and supply model representing the situation before the economic event took place.
Establishing this model requires four standard pieces of information:
• A downward sloping demand curve
• An upward sloping supply curve
• Correctly labeled axes: a vertical axis labeled price and a horizontal axis labeled quantity
• An initial equilibrium price and quantity. It is a good practice to indicate these on the axes, rather than in the interior of the graph.
Step 2. Decide whether the economic event being analyzed affects demand or supply.
In other words, does the event refer to something in the list of demand factors or supply factors?
Step 3. Decide whether the effect on demand or supply causes the curve to shift to the right or to the left, and sketch the new demand or supply curve on the diagram.
You can think about it this way: Does the event change the amount consumers want to buy or the amount producers want to sell?
Step 4. Identify the new equilibrium and then compare the original equilibrium price and quantity to the new equilibrium price and quantity.
The best way to get at this process is to try it out a couple of times! Let’s first consider an example that involves a shift in supply, then we'll move on to one that involves a shift in demand. Finally, we'll consider an example where both supply and demand shift.

## Shift in supply: good weather for salmon fishing

In the summer of 2000, weather conditions were excellent for commercial salmon fishing off the California coast. Heavy rains meant higher than normal levels of water in the rivers, which helped the salmon to breed. Slightly cooler ocean temperatures stimulated the growth of plankton—the microscopic organisms at the bottom of the ocean food chain—providing everything in the ocean with a hearty food supply. The ocean stayed calm during fishing season, so commercial fishing operations did not lose many days to bad weather.
How did these climate conditions affect the quantity and price of salmon? We can get to the answer by working our way through the four-step process you learned above.
The demand and supply model and table below provide the information we need to get started!
Salmon Fishing
Price per poundQuantity supplied in 1999Quantity supplied in 2000Quantity demanded
$2.0080400840$2.25120480680
$2.50160550550$2.75200600450
$3.00230640350$3.25250670250
$3.50270700200 Step 1. Draw a demand and supply model representing the situation before the economic event took place. In this example, our demand and supply model will illustrate the market for salmon in the year before the good weather conditions began—you can see it above. The demand curve $\text{D0}$ and the supply curve $\text{S0}$ show that the original equilibrium price was$3.25 per pound and the original equilibrium quantity was 250,000 fish. This price per pound is what commercial buyers pay at the fishing docks; what consumers pay at the grocery is higher.
Step 2. Decide whether the economic event being analyzed affects demand or supply.
In our fishing example, good weather is an example of a natural condition that affects supply.
Step 3. Decide whether the effect on demand or supply causes the curve to shift to the right or to the left, and sketch the new demand or supply curve on the diagram.
We need to determine if the the effect on supply in our example was an increase or a decrease. Good weather is a change in natural conditions that increases the quantity supplied at any given price. Because of this, the supply curve shifts to the right, moving from the original supply curve $\text{S0}$ to the new supply curve $\text{S1}$. You can see the shift in both the demand and supply model and in the table.
Step 4. Identify the new equilibrium and then compare the original equilibrium price and quantity to the new equilibrium price and quantity.
At the new equilibrium $\text{E1}$, the equilibrium price falls from $3.25 to$2.50, but the equilibrium quantity increases from 250,000 to 550,000 salmon. Notice that the equilibrium quantity demanded increased, even though the demand curve did not move.
What do those numbers mean exactly? In short, good weather conditions increased supply of the California commercial salmon. The result was a higher equilibrium quantity of salmon bought and sold in the market at a lower price.

## Shift in demand: newspapers and the internet

According to the Pew Research Center for People and the Press, more and more people—especially younger people—are getting their news from online and digital sources. The majority of US adults now own smartphones or tablets, and most of those Americans say they use these devices in part to get the news. From 2004 to 2012, the share of Americans who reported getting their news from digital sources increased from 24% to 39%.
How has this shift in behavior affected consumption of print news media and radio and television news?
Let's use our four-step process again to figure it out. You'll find all the info you need in the demand and supply model below.
Step 1. Draw a demand and supply model representing the situation before the economic event took place.
In this case, we want our demand and supply model to represent the time before many Americans began using digital and online sources for their news. You'll notice in this demand and supply model—above—that the analysis was performed without specific numbers on the price and quantity axes.
Step 2. Decide whether the economic event being analyzed affects demand or supply.
A change in tastes from traditional news sources—print, radio, and television—to digital sources caused a change in demand for the former.
Step 3. Decide whether the effect on demand or supply causes the curve to shift to the right or to the left, and sketch the new demand or supply curve on the diagram.
A shift to digital news sources will tend to mean a lower quantity demanded of traditional news sources at every given price, causing the demand curve for print and other traditional news sources to shift to the left, from ${\text{D}}_{0}$ to ${\text{D}}_{1}$.
Step 4. Identify the new equilibrium and then compare the original equilibrium price and quantity to the new equilibrium price and quantity.
The new equilibrium—${\text{E}}_{1}$—occurs at a lower quantity and a lower price than the original equilibrium—${\text{E}}_{0}$.
So, what do we know now about the effect of the increased use of digital news sources? We know—based on our four-step analysis—that fewer people desire traditional news sources, and that these traditional news sources are being bought and sold at a lower price.

## A combined example: the US Postal Service

In the real world, many factors affecting demand and supply can change all at once. For example, more and more people are using email, text, and other digital message forms such as Facebook and Twitter to communicate with friends and others, and at the same time, compensation for postal workers tends to increase most years due to cost-of-living increases.
Additionally, an increase in the use of digital forms of communication will affect many markets, not just the postal service. How can an economist sort out all these interconnected events? The answer lies in the ceteris paribus—Latin for "other things equal"—assumption. We must look at how each economic event affects each market, one event at a time, holding all else constant. Then, we combine the analyses to see the net effect.
Let's use our four-step analysis to determine how the increased use of digital communication and the increase in postal worker compensation will affect the viability of the Postal Service.
Since this problem involves two disturbances, we need two four-step analyses—the first to analyze the effects of higher compensation for postal workers and the second to analyze the effects of many people switching from "snail mail" to email and other digital messages.

### Analysis of increase in postal worker compensation

Step 1. Draw a demand and supply model representing the situation before the economic event took place.
In this example, we want our demand and supply model to illustrate what the market looked like before US postal worker compensation increased. The demand curve ${\text{D}}_{0}$ and the supply curve ${\text{S}}_{0}$ in demand and supply model A—above left—show the original relationships.
Step 2. Decide whether the economic event being analyzed affects demand or supply.
Labor compensation is a cost of production. A change in production costs causes a change in supply for the postal services.
Step 3. Decide whether the effect on demand or supply causes the curve to shift to the right or to the left, and sketch the new demand or supply curve on the diagram.
Higher labor compensation leads to a lower quantity supplied of postal services at every given price, causing the supply curve for postal services to shift to the left, from ${\text{S}}_{0}$ to ${\text{S}}_{1}$.
Step 4. Identify the new equilibrium and then compare the original equilibrium price and quantity to the new equilibrium price and quantity.
The new equilibrium—${\text{E}}_{1}$—occurs at a lower quantity and a higher price than the original equilibrium—${\text{E}}_{0}$.

### Analysis of increase in use of digital communication

Step 1. Draw a demand and supply model representing the situation before the economic event took place.
In this example, we want our demand and supply model to illustrate what the market looked like before the use of digital communication increased. The demand curve ${\text{D}}_{0}$ and the supply curve ${\text{S}}_{0}$ in demand and supply model B—above right—show the original relationships. Note that demand and supply model B is independent from demand and supply model A.
Step 2. Decide whether the economic event being analyzed affects demand or supply.
A change in tastes away from "snail mail" toward digital messages will cause a change in demand for the Postal Service.
Step 3. Decide whether the effect on demand or supply causes the curve to shift to the right or to the left, and sketch the new demand or supply curve on the diagram.
A shift to digital communication will tend to mean a lower quantity demanded of traditional postal services at every given price, causing the demand curve for print and other traditional news sources to shift to the left, from ${\text{D}}_{0}$ to ${\text{D}}_{1}$.
Step 4. Identify the new equilibrium and then compare the original equilibrium price and quantity to the new equilibrium price and quantity. The new equilibrium—$\text{E2}$—occurs at a lower quantity and a lower price than the original equilibrium—${\text{E}}_{0}$.
The final step in a scenario where both supply and demand shift is to combine the two individual analyses to determine what happens to the equilibrium quantity and price. One way to do this is to graphically superimpose the two diagrams one on top of the other, as we've done below.
By examining the combined demand and supply model, we can come to the following conclusions.
Effect on quantity: Higher postal worker labor compensation raises the cost of production of postal services, which decreases the equilibrium quantity. A change in tastes away from "snail mail" also decreases the equilibrium quantity. Since both shifts are to the left, the overall impact is a decrease in the equilibrium quantity of postal services—${\text{Q}}_{3}$. We can see this graphically since ${\text{Q}}_{3}$ is to the left of ${\text{Q}}_{0}$.
Effect on price: The overall effect on price is more complicated. Higher postal worker labor compensation raises the cost of production, increasing the equilibrium price. But, a change in tastes away from "snail mail" decreases the equilibrium price. Since the two effects are in opposite directions, the overall effect is unclear, unless we know the magnitudes of the two effects. But don't worry; we haven't done anything wrong! When both curves shift, typically we can determine the overall effect on price or on quantity, but not on both. In this case, we determined the overall effect on the equilibrium quantity but not on the equilibrium price. In other cases, it might be the opposite.
It's also important to keep in mind that economic events that affect equilibrium price and quantity may seem to cause immediate change when examining them using the four-step analysis. As a practical matter, however, prices and quantities often do not zoom straight to equilibrium. More realistically, when an economic event causes demand or supply to shift, prices and quantities set off in the general direction of equilibrium. Indeed, even as they are moving toward one new equilibrium, prices are often then pushed by another change in demand or supply toward another equilibrium.
And finally, a word of caution—one common mistake when analyzing the affects of an economic event using the four-step system is to confuse shifts of demand or supply with movements along a demand or supply curve.

## Summary

When using the supply and demand framework to think about how an event will affect the equilibrium price and quantity, proceed through four steps:
Step 1. Draw a demand and supply model representing the situation before the economic event took place.
Step 2. Decide whether the economic event being analyzed affects demand or supply.
Step 3. Decide whether the effect on demand or supply causes the curve to shift to the right or to the left, and sketch the new demand or supply curve on the diagram.
Step 4. Identify the new equilibrium and then compare the original equilibrium price and quantity to the new equilibrium price and quantity.

## Self-check questions

From August 2014 to January 2015, the price of jet fuel decreased roughly 47%. Using the four-step analysis, how do you think this fuel price decrease affected the equilibrium price and quantity of air travel?
A tariff is a tax on imported goods. Suppose the US government cuts the tariff on imported flatscreen televisions. Using the four-step analysis, how do you think the tariff reduction will affect the equilibrium price and quantity of flatscreen TVs?

## Review questions

• How can you analyze a market where both demand and supply shift?
• What causes a movement along the demand curve? What causes a movement along the supply curve?

## Critical-thinking questions

• Use the four-step process to analyze the impact of the advent of the iPod and other portable digital music players on the equilibrium price and quantity of the Sony Walkman and other portable audio cassette players.
• Use the four-step process to analyze the impact of a reduction in tariffs on imports of iPods on the equilibrium price and quantity of Sony Walkman-type products.
• Suppose both of these events took place at the same time. Combine your analyses of the impact of the iPod and the impact of the tariff reduction to determine the likely combined impact on the equilibrium price and quantity of Sony Walkman-type products. Show your answer graphically.

## Practice problems

Problem 1: cheese
Demand and supply in the market for cheddar cheese is illustrated in the table below. Graph the data and find the equilibrium.
Next, create a table showing the change in quantity demanded or quantity supplied and a graph of the new equilibrium in each of the following situations:
• The price of milk, a key input for cheese production, rises so that the supply decreases by 80 pounds at every price.
• A new study says that eating cheese is good for your health, so demand increases by 20% at every price.
Price per poundQdQs
$3.00750540$3.20700600
$3.40650650$3.60620700
$3.80600720$4.00590730
Problem 2: movie tickets
Supply and demand for movie tickets in a city are shown in the table below. Graph demand and supply and identify the equilibrium. Then, calculate in a table and graph the effect of the following two changes:
• Three new nightclubs open. They all offer decent bands and have no cover charge, but they make their money by selling food and drink. As a result, demand for movie tickets falls by 6 units at every price.
• The city eliminates a tax that it had been placing on all local entertainment businesses. The result is that the quantity supplied of movies at any given price increases by 10%.
Price per ticketQdQs
$5.002616$6.002418
$7.002220$8.002121
\$9.002022

## Want to join the conversation?

• What happens to the equilibrium in price and quantity using demand and supply curves when the demand for gasoline if the price rises?
• If you are asking: "What would happen with the demand and supply curves if the price of gasoline rose?", my answer would be:

If I understood the article right, when the price of gasoline rises, there is no shift of the demand or supply curves. We just move up along the demand curve. There will be less quantity demanded.
• Can we imagine a situation in which both supply and demand would be reduced drastically and constantly (both supply and demand curves moving leftwards) up to a point in which the final equilibrium would be at Quantitity = 0?
• How about a total shift or change of technology.
For instance the way we communicate has changed from a land-line to cell phone. Before that it was a telegraph. Outside of a very few collectors, I think it's safe to say 'we', as a community, no longer demand telegraphs, and suppliers will no longer supply them, as our tech has moved beyond that.
• In the Jet fuel price problem, why can't we make analysis form the Demand perspective, given the fact that the reduction in fuel prices will ultimately affect the travel charges and consequently more number of people would prefer to travel via flight?
• We are taking both supply and demand into consideration. Due to competition, airlines will lower their prices, and more people will fly. It is the supply curve that shifts, however. Nothing changed in customer preferences: they would be willing to fly the same amount for every price point as before. The difference is that airlines can now afford to provide more flights at each of those price points.

"A tariff reduction is equivalent to a decrease in the cost of production, which we can show as a rightward—or XXX downward XXX —shift in supply." XXX SHOULD BE UPWARD, NOT DOWNWARD XXX. This seems like a very sloppy error for basic economic instruction that can really confuse students? Please correct me if I am wrong ....
• When we talk about cost of production, the supply can be increased at a cheaper price if the tariff decreases- therefore, it shifts downwards.
• So in the questions regarding iPods and Walkmans...

a) the advent of iPod lowers demand for walkman
b) reduction of tarrifs for iPods lowers supply for walkman
c) taken together both the supply and demand are lowered

So in the end, the final equilibrium quantity goes to the lowest points while the eq. price goes to the second lowest point (the lowest being the scennario in b, where only the supply was affected).

Is this correct?
• Journeyman, regarding point B here is how I interpreted it. Maybe I am wrong but a reduction of tariffs for iPods increases supply of iPods (shift to the right) which would cause a drop in the price of the iPod. The iPod being a substitute product to the Sony Walkman, a drop in the price of the iPod, would decrease the demand for the Walkman.

So all in all, supply for walkmans stays the same, and demand for walkmans shifts twice to the left.
• Is it a mistake that there isn't a price 3 for E 3 at picture Image credit: Figure 4 ?
• what causes the shifting in demand and supply curve
• Changes in quantity supplied and quantity demanded.
(1 vote)
• In the section about the "newspapers and the internet", it is written that the demand of newspapers is affected by the new advancements in technology. Wouldn't it also affect the supply as well, since the production of newspapers would decrease?
(1 vote)
• You are confusing movement along a curve with a shift in the curve. And confusing change in supply with change in quantity supplied.
The existence of online news as a substitute for newspapers causes a reduction in demand. What we mean when we say reduction in demand is that the quantity demanded - at all prices - is less than it was before. That's a shift in the entire demand curve to the left. The RESULT of this is that - all else being equal - the price of newspapers will fall, and the QUANTITY SUPPLIED will also fall. But it is really important to understand that this change in quantity supplied is different from a change in supply. A change in supply refers to a shift in the entire supply curve, so that the quantity supplied - at any price - is different from what it was before.

Summary:
"Demand change" => shift of the demand curve. Happens for reason OTHER THAN PRICE.
"Supply change" => shift of the supply curve. Happens for reason OTHER THAN PRICE.

Change in quantity demanded => movement ALONG the demand curve, BECAUSE OF PRICE.
Change in quantity supplied => moment ALONG the supply curve, BECAUSE OF PRICE.