analysing-changes-to-market-equilibrium

Causes & Consequences of Price Changes

• Real world markets are constantly changing and are referred to as dynamic markets

• Market equilibrium can change every few minutes in some markets (e.g. stocks and shares), or every few weeks or months in others (e.g clothing)

•  Any change to a condition of demand or supply will temporarily create disequilibrium, and market forces will then seek to clear the excess demand or supply

Real World Example One: Changes to Demand that Increase Price

• During lock downs associated with the Covid-19 pandemic, furniture retailers experienced unexpectedly high demand for their products (especially desks and sofas)

Diagram: Increase in Demand

Diagram analysis

• Due to the Covid mandated change of working from home, consumers experienced a temporary change in taste as they sought to set up comfortable home offices

  • This led to an increase in demand for desks from D₁ → D₂

• At the original market clearing price of P₁, a condition of excess demand now exists

  • The demand for desks is greater than the supply

• In response, suppliers raise prices

  • This causes a contraction of demand and an expansion of supply, leading to a new market equilibrium at P₂Q₂

  • Both the equilibrium price (P₂) and the equilibrium quantity (Q₂) are higher than before

  • The excess demand in the market has been cleared

Real World Example Two: Changes to Supply that Increase Price

• In September 2022, Hurricane Fiona destroyed much of Puerto Rico’s crop of plantains (a necessity in the diet of local people)

Diagram: Decrease in Supply

Diagram analysis

• Due to Hurricane Fiona, Puerto Rico is experiencing a supply shock in its plantain market

  • This causes a decrease in supply of S₁ → S₂

• At the original market clearing price of P₁, a condition of excess demand now exists (shortage)

  • The demand for plantain is greater than the supply

• In response, sellers in Puerto Rico raised prices

  • This causes a contraction of demand and an expansion of supply leading to a new market equilibrium at P₂Q₂

  • The equilibrium price (P₂) is higher, and the equilibrium quantity (Q₂) is lower than before

  • The excess demand in the market has been cleared

Real World Example Three: Changes to Demand that Decrease Price

• Demand for lobsters in Maine, USA, has been falling steadily in recent months

• This has resulted in a price fall from $12.35 per pound on the 1st April to $9.35 per pound on the 1st May

Diagram: Decrease in Demand 

Diagram analysis

• In recent months, the USA has been experiencing an increasing rate of inflation

  • Inflation lowers the purchasing power of money in a consumer’s pocket and so effectively reduces their real income

  • With reduced real income, fewer luxuries are consumed

  • This led to a decrease in demand for lobsters from D₁ → D₂

• At the original market clearing price of P₁, a condition of excess supply now exists

  • The demand for lobsters is less than the supply

• In response, suppliers gradually reduce prices

  • This causes a contraction of supply and an expansion of demand, leading to a new market equilibrium at P₂Q₂

  • Both the equilibrium price (P₂) and the equilibrium quantity (Q₂) are lower than before

  • The excess supply in the market has been cleared

Real World Example Four: Changes to Supply that Decrease Price

• In order to help meet their climate targets and to lower energy costs for households, the EU is providing subsidies for solar panels 

Diagram: Increase in Supply

Diagram analysis

• To help meet its climate change targets and lower household energy bills, the EU has provided a subsidy to solar panel retailers

  • This causes an increase in supply of S₁ → S₂

• At the original market clearing price of P₁, a condition of excess supply now exists (surplus)

  • The supply of solar panels is greater than the demand

• In response, sellers in the EU lower prices

  • This causes an expansion of demand and a contraction of supply, leading to a new market equilibrium at P₂Q₂

  • The equilibrium price (P₂) is lower, and the equilibrium quantity (Q₂) is higher than before

  • The excess supply in the market has been cleared