From our last Lectures we now do know that Equilibrium prices are determined by the relative level of supply and demand. And that changes in supply and/or demand will cause change in the equilibrium price and/or quantity in a free market.
Let us provide some example to prove this:
1. Fall in Raw material Prices
A fall in the Raw Material Prices means an input of production now costs less. Which consequently associates to that fact that Supply for that particular product will increase as its Production costs lowers. Graphically:
- S shifts to S’
- Surplus at P1 between Q1, Q2
- Price adjusts to equilibrium at P3, Q3
2.An increase in Income
As we have describe in our previous lectures that Incomes is associated with Consumers. And consumers with Demand. An increase in Income leade to an increase in Consumer demand of a Particular Good. Note that I am not talking about what Kind of Good that is. But rather a commodity that all consumer buy when their Income Increase (Because there are also Inferior goods that Consumers don’t Buy when there income increases) . Graphically:
- Demand increases to D’
- Shortage at P1 of Q1 to Q2
- Equilibrium at P3 and Q3
Now lets take both of these examples altogether.
Incomes Increases and Raw Material Prices Fall
Below is the Graph shown for both the situations. An increase in Income as well as a Decrease in the Raw Material prices. The effect shows that there is a Higher Increase in the Quantity compared to the rise in Price. Note that the Size and direction of the Curve of Supply and demand gives us the indication of how much an increase could effect the equilibrium Price and Quantity. In the Graph, we see a small tendency of increase compared to a large amount of Increase in Demand. At one point when Raw material Prices Fall. Supply (Quantity) is increased. At the other we see an Increase in Demand (Quantity) Because of an Increase in Income. This Shows a greater amount of Increase in the Capacity of Quantity compared to the Price which shows a small increase.
- Quantity increases
- If the increase in D is greater than the increase in S price also increases .
When supply and demand change simultaneously, the impact on the equilibrium price and quantity is determined by:
- The relative size and direction of the change
- The shape of the supply and demand models
Next will be Elasticity….