Let's put together everything we've learned so far and use it to predict what will happen to equilibrium prices and quantities when something changes in the world. Let's go back to tacos and draw a basic set of supply and demand curves. Quantity, price, downward sloping demand, and upward sloping supply.
We'll mark off the equilibrium price and quantity. 100 tacos at $3. Remember, the product itself isn't what's important no matter how delicious it is. These principles about willingness to pay and willingness to accept apply broadly.
So, let's start with shifts in demand. It's the start of the new semester and college stations'population increases hugely with the influx of students moving in. What does that do to the demand curve?
At every price, there are more people willing to buy tacos. So the demand curve shifts to the right. What happens to the market equilibrium? At the old equilibrium price of three dollars, there are fewer tacos supplied than the number of tacos demanded.
So we know that prices will rise to meet that shift in demand. The quantity supplied will increase. Notice that I said that the quantity supplied moves up. Nothing happened to the supply curve itself.
It still got all else equal. So, we move up the supply curve to the new equilibrium. Let's say it's $3.50 with a quantity of $1.20.
The increase in demand led to an increase in price and an increase in quantity. So is that a violation of the law of demand? No, because we don't have all else equal here. We can also see what happens if demand decreases. Maybe a lot of people get into chicken fingers instead of tacos.
So at every price people want fewer tacos. Demand shifts the left. Now there's a surplus of tacos. More tacos are being supplied than being demanded.
Stores reduce the quantity supplied until we reach a new equilibrium where quantity supplied equals quantity demanded. Let's say the price of tacos falls to two dollars and the quantity demanded falls to three dollars. to 60. Both equilibrium price and quantity fall.
Again, it's not a violation of the law of demand because we aren't holding all else equal. The demand curve still slopes down, but the relationship between demand and supply has changed with the shift in demand. So, let's draw a fresh set of curves. Back to the same taco market in town with the same equilibrium price. and quantity downward sloping demand and upward sloping supply an equilibrium quantity or equilibrium price of three dollars and equilibrium quantity of a hundred because of course we have quantity over here and price over here.
Let's focus now on changes in supply. Let's say that the price of flour falls. I usually prefer flour tortillas, if that's alright with you.
So what does that mean for supply? It's now cheaper to make each taco. The marginal cost of a taco has fallen because the price of an input has fallen. That's the interdependence principle at work. The flour market affects the taco market.
So at every quantity, producers are willing to accept a lower price for their tacos because it's easier to cover their costs. To put it another way, at every price, producers are willing to sell more because they can do it more cheaply. Supply increases and shifts to the right. So now at the old equilibrium price, There are more tacos being supplied than being demanded, a surplus. So the price will fall until the willingness to pay for a taco equals the willingness to accept, where the marginal benefit of a taco equals its marginal cost.
So we could say that this was $2. and 120 tacos. Now instead, suppose that wages go up.
And we'll talk about labor markets soon. Workers are an input to making tacos and the price of that input has now gone up. The marginal cost of a taco has increased.
So at every price, shops are willing to sell fewer tacos. And the supply curve shifts this way. At the old equilibrium price, there's a shortage.
People want more tacos than shops are willing to sell at that price. So the price increases and the quantity falls. Now, most textbooks present this material in a way that makes it tempting to try to memorize it.
When demand increases, the equilibrium price and quantity increases. You can memorize these relationships, but I really recommend against it. You might blank out on the exam or get confused and talk yourself out of the right answer.
This stuff is much easier if you understand the basic principles underlying it. More love for tacos means that people want more at every price. This shifts the demand curve to the right. Where does it now intersect the supply curve which didn't move?
Review the content, especially the dozen examples in the textbook reading for this section, and make sure you understand why the equilibrium prices and quantities move the way they do. Don't work hard to not think.