Previously, we explained the factors that influence the demand for goods and services, particularly how a change in the price affects the quantity demanded. We also explained the factors that influence the supply of goods and services and we paid particular attention to how a change in the price affects the quantity supplied. We ended by combining demand and supply to show how price is established through the interaction of the forces of demand and supply.
We indicated that whenever excess demand (shortage) or excess supply (surplus) exists in a market, the price of the good or service will change to ensure that equilibrium (where the quantity demanded equals the quantity supplied) is reached. In the event of excess supply (or surplus), the price will fall, and in the event of excess demand (or shortage), the price will rise.
We will now focus on how markets react to changes. Changes are continually taking place in the world. For example, household income changes, consumers' tastes and preferences for a product shift, the cost of production increases, new technologies are implemented and new resources are discovered.
Markets react to these changes. This is most noticeable in changes in the price of the goods and services that society produces and consumes. Underlying these price changes are changes in the demand for and supply of goods and services.
In this section, we explain how equilibrium is re-established in a market after a change in either demand or supply has taken place. You will notice that changes in price play a major role in re-establishing equilibrium.
Most people do not like price changes. However, these changes play a key role in the economy, and by watching prices, consumers and producers can learn a lot about what is happening and what is going to happen.
For example, an increase in the price of red meat because of an increase in household income tells you that red meat is in shorter supply and that you (as the consumer) should cut back on your red meat consumption. However, for suppliers, an increase in the price of red meat might be an alert to produce more red meat as well as an incentive to do so.
We start this section by discussing how changes in demand affect the market and then go on to explain how changes in supply affect the market. We then show how simultaneous changes in demand and supply has an impact on the market.