Econ1101EquilMultShifts

1 Change in Equilibrium with Multiple Market Shifters These are notes about how changes in the market will affect equilibrium (price and quantity). This is a topic we discussed in lecture today, Wednesday, June 25 th . These notes should be helpful when doing HWII. First we will look at some examples when only one factor changes (only one curve shifts). Then we will discuss the more complicated case when two factors change at once, and look at a couple examples. We are interested in what happens to the equilibrium of the market when some factor changes either demand or supply. Remember, the Demand and Supply Shifters: Demand Shifters 1. Income 2. Prices of related goods 3. Tastes & Preferences 4. Number of buyers Supply Shifters 1. Input Prices 2. Technology 3. Number of Sellers 4. Acts of Nature One Shifter In class I gave the following steps for determining the change in equilibrium caused by a market shifter. Step 0: Identify the initial equilibrium. Step 1: Determine if the change is a demand or supply shifter. Step 2: Determine which direction this shifter moves the particular curve (justify assumptions). Step 3: Note the new equilibrium & how P* and Q* have changed. 2 Example: (Market for Big Macs) Step 0: Change 1: Due to sanitary conditions, a large portion of cattle stock is considered un- edible (price of existing cattle increases). Step 1: Supply shifter ? price of input increases Step 2: Negative shifter, supply decreases Step 3: P 2 *> P 1 * and Q 2 *< Q 1 * P Q Market for Big Macs D 1 S 1 P 1 * Q 2 * S 2 Q 1 * P 2 * P Q Market for Big Macs D 1 S 1 P 1 * Q 1 * 3 Change 2: A consumer?s income increases Step 1: Demand shifter ? income Step 2: Must state assumption: normal or inferior good Either is fine, but must state it Say Big Macs are normal goods, positive shifter, Demand increases Step 3: P 2 *> P 1 * and Q 2 *> Q 1 * Two Shifters Now let?s suppose two factors change at the same time. We can still use the same process as above, but now steps 1 & 2 will involve analysis of multiple shifts. Also, step 3 is a little more complicated. We can see this by working an example. Example 1: (Market for Televisions) Step 0: P Q Market for Big Macs D 1 S 1 P 1 * Q 2 *Q 1 * P 2 * D 2 4 Suppose that: (a) The price of satellite service decreases dramatically (b) A major television producer leaves the market Step 1: (a) is Demand shifter ? price related good (b) is Supply shifter ? number producers Step 2: (a) is a positive shifter, price of complement good decreases, Demand increases (b) is a negative shifter, fewer producers, Supply decreases Step 3: As I said above, this step can be a bit complicated. To see this, consider the two following diagrams ? both of which increase demand and decrease supply. P Q Market for Televisions (Diagram 1) D 1 S 1 P 1 * Q 1 * D 2 S 2 Q 2 * P 2 * P Q Market for Televisions D 1 S 1 P 1 * Q 1 * 5 First, again notice that both of these diagrams satisfy the fact that Demand is increasing and Supply is decreasing. Now notice that in both diagrams P 2 *> P 1 *. However, in Diagram 1 Q 2 *> Q 1 * and in Diagram 2 Q 2 *< Q 1 *. This is an example of: An Important Fact: When both Demand and Supply shift one of the two possibilities will occur: The change in equilibrium price will be certain (either a definite increase or a definite decrease) while the change in equilibrium quantity will be ambiguous (could be either an increase, decrease or no change, depending on how much each curve is shifted). OR The change in equilibrium quantity will be certain (either a definite increase or a definite decrease) while the change in equilibrium price will be ambiguous (could be either an increase, decrease or no change, depending on how much each curve is shifted). To see that in the above example (Demand increasing, Supply decreasing) that equilibrium price will definitely increase, while change in equilibrium quantity will be ambiguous, consider each curve shift individually. Change in Curve Change in P* Change in Q* Increase in Demand Increase Increase Decrease in Supply Increase Decrease Overall Change Increase Ambiguous An increase in demand increases P*. A decrease in supply increases P*. Thus these two shifts working together will increase P*. P Q Market for Televisions (Diagram 2) D 1 S 1 P 1 * Q 1 * D 2 S 2 Q 2 * P 2 * 6 An increase in demand increases Q*. A decrease in supply decreases Q*. When we combine these two shifts, the result is uncertain (ambiguous). It depends on which curve shifts more ? demand or supply. It is possible to have Q* either increase, decrease or remain the same (all of these cases can be drawn). When working problems such as this, be sure to say if P* or Q* either changes with certainty (then say if it increases or decreases) or if the change is ambiguous. Example 2: (Market for Televisions) Step 0: Suppose that: (a) A conclusive study shows that TV really does rot the brain (b) The prices of plastic, glass and electrical cords go up Step 1: (a) is Demand shifter ? tastes and preferences (b) is Supply shifter ? price of inputs Step 2: (a) is a negative shifter, Demand decreases (b) is a negative shifter, Supply decreases Step 3: One possibility for the new market: P Q Market for Televisions D 1 S 1 P 1 * Q 1 * 7 We can see from this diagram that Q* definitely falls (Q 2 *< Q 1 *) but the change in P* is ambiguous. This is because a decrease in supply and a decrease in demand both lead to a lower Q*, while a decrease in supply pushes up P* and a decrease in demand pushes down P*. When we combine these two effects, Q* will definitely fall, while the change in P* is ambiguous. Again, we can use a table to help see this: Change in Curve Change in P* Change in Q* Decrease in Demand Decrease Decrease Decrease in Supply Increase Decrease Overall Change Ambiguous Decrease P Q Market for Televisions D 1 S 1 P 1 * Q 1 * D 2 S 2 Q 2 * P 2 * walrath Microsoft Word - Econ1101EquilMultShifts.doc