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LONG-RUN EQUILIBRIUM CONDITIONS: The long-run equilibrium of perfectly competitive industry generates six specific equilibrium conditions, including (1) economic efficiency (P = MC), (2) profit maximization (MR = MC), (3) perfect competition (MR = AR = P), (4) breakeven output (P = AR = ATC), (5) minimum production cost (MC = ATC), and (6) minimum efficient scale (MC = ATC = LRAC = LRMC).

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DEMAND INCREASE AND SUPPLY DECREASE:

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

Simultaneous Shocks

To see how an increase in demand and a decrease 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 buyers have it on good authority that the price of Hot Momma Fudge Bananarama Ice Cream Sundaes will be going higher. Seeking to stock up on this delectable dessert, buyers buy more now. This triggers the buyers' expectations demand determinant, increases demand, and shifts the demand curve rightward.

  • Second, on the supply side, suppose that sellers have it on good authority that the price of Hot Momma Fudge Bananarama Ice Cream Sundaes will be going higher. Hot Momma Fudge Bananarama Ice Cream Sundaes suppliers, seeking to sell their wares at the highest possible price, reduce their current sundae offerings, opting to wait for higher future price. This activates the sellers' expectations supply determinant, decreases supply, and shifts the supply curve leftward.

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 the expected price 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 expected price causes a decrease in supply and a leftward shift of the supply curve. This creates a temporary shortage. This shortage causes the price to increase. The higher price eliminates the shortage, and the resulting equilibrium quantity decreases. By itself, a decrease in supply leads to a higher price and a smaller quantity. Click the [Supply Decrease] button to illustrate.

Both at Once

Now consider simultaneous shifts of Both Curves. Combining both shifts generates an obvious change in price, but a questionable change in quantity. If an increase in demand increases equilibrium price and a decrease in supply increases equilibrium price, then both together MUST increase equilibrium price. The market price of Hot Momma Fudge Bananarama Ice Cream Sundaes in Shady Valley is higher.

But what about quantity? The demand shift results in a larger quantity, and the supply shift leads to a smaller quantity. Does quantity end up more or less? Who knows? No one does, not with the available information. The quantity 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 demand and a decrease in supply. The demand curve shifts to the right and the supply curve shifts to the left. The resulting equilibrium can be identified by clicking the [New Equilibrium] button. The equilibrium price is now Pe, which as expected is an increase over the original equilibrium price. Buyers are willing to pay more and sellers want to charge more. The price increases.

What about quantity? In this little illustration, the new equilibrium quantity happens to be unchanged at Qo, the original equilibrium quantity. Maintaining the same equilibrium quantity, 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 quantity would have ended up greater or less than the original. Quantity is indeterminant.

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

One of Eight

A demand increase and supply decrease 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 increase, demand and supply decrease, and demand decrease and supply increase.

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Recommended Citation:

DEMAND INCREASE AND SUPPLY DECREASE, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2014. [Accessed: October 25, 2014].


Check Out These Related Terms...

     | demand and supply increase | demand 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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