SHORT-RUN AGGREGATE SUPPLY AND MARKET SUPPLY: The short-run aggregate supply curve, or SRAS curve, has similarities to, but differences from, the standard market supply curve. Both are positively sloped. Both relate price and quantity. However, the market supply curve is positively sloped due to the law of diminishing marginal returns and the short-run aggregate supply curve is positively-sloped due to inflexible prices, the pool of natural unemployment, and imbalances in real resource prices.
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DEMAND AND SUPPLY DECREASE:
A simultaneous decrease in the willingness and ability of buyers to purchase a good at the existing price, illustrated by a leftward 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 a decrease in equilibrium quantity and an indeterminant change in equilibrium price. A demand decrease 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 decrease results in a decrease in equilibrium quantity and a decrease in equilibrium price. By itself a supply decrease results in a decrease in equilibrium quantity and an increase in equilibrium price. A simultaneous decrease in demand and decrease in supply unquestionably generates a decrease 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 ShocksTo see how a decrease 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 a horrific plague kills half of the residents of the Shady Valley. This is clearly a devastating event if for no other reason than it reduces the number of buyers in the market for Hot Momma Fudge Bananarama Ice Cream Sundaes. This activates the number of buyers demand determinant, decreases demand, and shifts the demand curve leftward.
- Second, on the supply side, suppose that sellers anticipate a likely increase in the price of Hot Momma Fudge Bananarama Ice Cream Sundaes in the weeks and months ahead. 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
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.
|Demand and Supply
- A decrease in the number of buyers causes a decrease in demand and a leftward shift of the demand curve. This creates a temporary surplus. The surplus causes the price to decrease. The lower price eliminates the surplus and the resulting equilibrium quantity decreases. By itself, a decrease in demand leads to a lower price and a smaller quantity. Click the [Demand Decrease] 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, but 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 OnceNow consider simultaneous shifts of both curves. Combining both shifts generates an obvious change in quantity, but a questionable change in price. If a decrease in demand decreases equilibrium quantity and a decrease in supply decreases equilibrium quantity, then a decrease in both MUST decrease equilibrium quantity. Fewer Hot Momma Fudge Bananarama Ice Cream Sundaes are exchanged in Shady Valley.
But what about price? The demand shift results in a lower price, and the supply shift leads to a higher price. Does price end up higher or lower? Who knows? No one does, not with the available information. The price is indeterminant.
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 a decrease in both demand and supply. Both curves shift to the left. The resulting equilibrium can be identified by clicking the [New Equilibrium] button. The equilibrium quantity is now Qe, which as expected is a decrease over the original equilibrium quantity. Buyers want to buy less and sellers want to sell less. The quantity decreases.
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 lower price outweighs the supply-induced higher price, and the price is lower. A higher 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 EightA demand 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 increase and supply decrease, and demand decrease and supply increase.
DEMAND AND SUPPLY DECREASE, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2024. [Accessed: February 27, 2024].
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