Market Dynamics: Demand Shifts, Supply Changes, and Price Controls
Understanding the Demand Curve
The Law of Demand
If price is on the vertical axis and quantity demanded is on the horizontal axis, the demand curve is downward sloping (left to right).
This slope is the graphical representation of the Law of Demand, which specifies an inverse relationship between price and quantity demanded, ceteris paribus (all other factors held constant).
Movement Along the Demand Curve
- When moving along a specific demand curve, the factor that is not held constant is the price of the good for which the demand curve is relevant.
Factors Causing Demand Curve Shifts
A shift in the demand curve (a change in demand) occurs when a non-price determinant changes:
- Rightward Shift (Increase in Demand):
- A fall in the price of a complementary good (e.g., a fall in the price of tennis rackets increases demand for tennis balls).
- An increase in the expected future price of the product (e.g., increased expected future price of maize increases current demand for maize).
- Increased consumer preference or taste for the product (e.g., people favoring romance novels more).
- Leftward Shift (Decrease in Demand):
- A decrease in the number of buyers in an area.
Identifying Substitutes
If an increase in the price of good B causes an increase in the demand for good C, this indicates that B and C are substitutes.
Factors Affecting Product Supply
Understanding Supply Curve Shifts
When the supply of a product increases, the supply curve shifts rightward. This means that at each price, producers want to produce and sell more than before.
Causes of a Rightward Shift (Increase in Supply)
- A decrease in the price of a resource (input) used to produce the product.
- Discovery of a new and cheaper production method (improved technology).
- If technology used to produce product D improves, reducing costs, this leads to:
- An increase in the supply of D.
- A surplus of D at the initial price.
- A decrease in the equilibrium price of D.
Causes of a Leftward Shift (Decrease in Supply)
- An increase in the price of an input used to produce the product.
- If the price of an input used to produce product C increases, this leads to:
- A decrease in the supply of C.
- A shortage of C at the initial price.
- An increase in the equilibrium price of C.
- A decrease in the quantity demanded of C (due to the higher price).
Factors That Do Not Shift the Supply Curve
The following changes affect demand or movement along the curve, but do not shift the supply curve:
- A change in the price of the product itself.
- An increase in consumer income.
- An increase in the price of a substitute for the good (this affects demand, not supply).
Market Equilibrium and Government Intervention
Surplus and Shortage
- At a price above the equilibrium price, there is a surplus (or excess supply).
- At a price below the equilibrium price, there is a shortage (or excess demand).
- If there is a surplus in a market:
- Quantity demanded is less than quantity supplied.
- The price of the product will fall if the government does not intervene.
Price Floors (Minimum Prices)
A price floor is a government-mandated minimum price.
- A surplus could be caused by a price floor set above the equilibrium level.
- An effective price floor will result in a surplus.
Price Ceilings (Maximum Prices)
A price ceiling is a government-mandated maximum price above which legal trades cannot be made.
- A shortage could be caused by a price ceiling set below the equilibrium level.
- When rent ceilings are imposed, requiring a tenant to purchase furniture as a condition of renting the apartment is considered a tie-in sale, often used to circumvent the price control.