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CHANGE IN BUSINESS INVENTORIES: The increase or decrease in the stocks of final goods, intermediate goods, raw materials, and other inputs that businesses keep on hand to use in production. This is one of two main categories of gross private domestic investment included in the National Income and Product Accounts maintained by the Bureau of Economic Analysis. The other category is fixed investment. Change in business inventories is NOT what most people think of when the topic of business investment arises. Inventory changes are considered investment because firms need inventories to smooth the flow of production and sales just like they need factories and equipment to produce goods. In fact, inventories are frequently termed "working capital."

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DEMAND AND SUPPLY INCREASE:

A simultaneous increase in the willingness and ability of buyers to purchase a good at the existing price, illustrated by a rightward shift of the demand curve, and an increase in the willingness and ability of sellers to sell a good at the existing price, illustrated by a rightward shift of the supply curve. When combined, both shifts result in an increase in equilibrium quantity and an indeterminant change in equilibrium price.
A demand increase results from a change in any of the five demand determinants. A supply increase results from a change in any of the five supply determinants. By itself, a demand increase results in an increase in equilibrium quantity and an increase in equilibrium price. By itself a supply increase results in an increase in equilibrium quantity and a decrease in equilibrium price. A simultaneous increase in demand and increase in supply unquestionably generates an increase in the quantity exchanged. However, the change in the price is indeterminant. It might rise or fall depending on the magnitude of the demand and supply changes.

Simultaneous Shocks

To see how an increase in demand and an increase in supply affects market equilibrium, consider the Shady Valley market for Hot Momma Fudge Bananarama Ice Cream Sundaes.

  • First, on the demand side, suppose that the Shady Valley economy begins to boom, meaning more people have more jobs and higher incomes. Without question, Hot Momma Fudge Bananarama Ice Cream Sundaes are a normal good. As such people demand more Hot Momma Fudge Bananarama Ice Cream Sundaes. The buyers' income demand determinant increases demand and shifts the demand curve rightward.

  • Second, on the supply side, suppose that not one, but three new Hot Momma Fudge Bananarama Ice Cream Shoppes begin operation in Shady Valley. As such the number of Hot Momma Fudge Bananarama Ice Cream Shoppes willing and able to sell Hot Momma Fudge Bananarama Ice Cream Sundaes is more. The number of sellers supply determinant increases supply and shifts the supply curve rightward.

One Shift at a Time

Demand and Supply

What do these shifts do to the hot fudge sundae market? Consider the shift of each curve separately. The diagram at the right presents the Shady Valley market for Hot Momma Fudge Bananarama Ice Cream Sundaes. The initial equilibrium price is Po and the initial equilibrium quantity is Qo. This market equilibrium, of course, persists until and unless a determinant changes, which is the nature of equilibrium.
  • An increase in buyers' income causes an increase in demand and a rightward shift of the demand curve. This creates a temporary shortage. The shortage causes the price to increase. The higher price eliminates the shortage and the resulting equilibrium quantity increases. By itself, an increase in demand leads to a higher price and a larger quantity. Click the [Demand Increase] button to illustrate.

  • An increase in the number of sellers causes an increase in supply and a rightward shift of the supply curve. This creates a temporary surplus. This surplus causes the price to decrease. The lower price eliminates the surplus, and the resulting equilibrium quantity increases. By itself, an increase in supply leads to a lower price and a larger quantity. Click the [Supply Increase] button to illustrate.

Both at Once

Now consider simultaneous shifts of both curves. Combining both shifts generates an obvious change in quantity, but a questionable change in price. If an increase in demand increases equilibrium quantity and an increase in supply increases equilibrium quantity, then an increase in both MUST increase equilibrium quantity. More Hot Momma Fudge Bananarama Ice Cream Sundaes are exchanged in Shady Valley.

But what about price? The demand shift results in a higher price, and the supply shift leads to a lower price. Does price end up higher or lower? Who knows? No one does, not with the available information. The price is indeterminant.

Doing Both

Consider both shifts using the diagram to the right. Once again the initial equilibrium price is Po and the initial equilibrium quantity is Qo.

Click the [Both Curves] button to see how the market is affected by an increase in both demand and supply. Both curves shift to the right. The resulting equilibrium can be identified by clicking the [New Equilibrium] button. The equilibrium quantity is now Qe, which as expected is an increase over the original equilibrium quantity. Buyers want to buy more and sellers want to sell more. The quantity increases.

What about price? In this little illustration, the new equilibrium price happens to be unchanged at Po, the original equilibrium price. Maintaining the same equilibrium price, however, is merely coincidence, happenstance, quite literally the luck of the draw.

In particular, the new demand and supply curves are drawn in such a way that they shift by the same amount. These two curves could have been drawn such that they shifted by different amounts. And if so, the price would have ended up higher or lower than the original. Price is indeterminant.

The reason for the indeterminant price is that the relative shift of each curve is unknown. If demand shifts relatively more than supply, then the demand-induced higher price outweighs the supply-induced lower price, and the price is higher. A lower price results if the supply shift is relatively more than the demand shift. Because the extent of each shift is not known, price is indeterminant. Whenever the demand and supply curves both shift, either quantity or price is indeterminant.

One of Eight

A demand and supply increase is one of eight market disruptions--four involving a change in either demand or supply and four involving changes in both demand and supply. The four single shift disruptions are demand increase, demand decrease, supply increase, and supply decrease. The other three double shifts are demand and supply decrease, demand increase and supply decrease, and demand decrease and supply increase.

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Recommended Citation:

DEMAND AND SUPPLY INCREASE, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2018. [Accessed: June 23, 2018].


Check Out These Related Terms...

     | demand and supply decrease | demand increase and supply decrease | demand decrease and supply increase | demand decrease | supply decrease | demand shock | supply shock |


Or For A Little Background...

     | demand decrease | supply increase | demand determinants | supply determinants | demand curve | supply curve | comparative statics | ceteris paribus | economic analysis | graphical analysis | market equilibrium | change in demand | change in supply |


And For Further Study...

     | price ceiling | price floor | market equilibrium, graphical analysis | aggregate market shocks |


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