Section 2 Changes in Market Equilibrium
Preview
Objectives
After studying this section you will be able to:
- Identify the determinants that create changes in price.
- Explain how a market reacts to a fall in supply by moving to a new equilibrium.
- Explain how a market reacts to shifts in demand by moving to a new equilibrium.
Section Focus
When a supply or demand curve shifts, a new equilibrium occurs. The market price and quantity sold move toward the new equilibrium.
Key Terms
- surplus
- shortage
- search costs
Economists say that a market will tend toward equilibrium, which means that the price and quantity will gradually move toward their equilibrium levels. Why does this happen? Remember that excess demand will lead firms to raise prices. Higher prices induce the quantity supplied to rise and the quantity demanded to fall until the two values are equal.
On the other hand, excess supply will force firms to cut prices. Falling prices will cause quantity demanded to rise and quantity supplied to fall until, once again, they are equal. Through these relationships, the market price and quantity sold of a good will move toward their equilibrium values.
Remember from Chapters 4 and 5 that all of the changes in demand and supply described above are changes along a demand or supply curve. Assuming that a market starts at equilibrium, there are two factors that can push it into disequilibrium: a shift in the entire demand curve and a shift in the entire supply curve.
Changes in Price
In Chapter 5, you read about the different factors that shift a supply curve to the left or to the right. These factors include advances in technology, new government taxes and subsidies, and changes in the prices of the raw materials and labor used to produce the good.
Since market equilibrium occurs at the intersection of a demand curve and a supply curve, a shift of the entire supply curve will change the equilibrium price and quantity. A shift in the supply curve to the left or the right creates a new equilibrium. Since markets tend toward equilibrium, a change in supply will set market forces into motion that lead the market to this new equilibrium price and quantity sold.
A functioning market will carefully balance supply and demand.
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