After you have worked through this section of the learning unit, you should be able to:
- use a market diagram to illustrate and explain the likely impact of a decrease in demand and a decrease in supply on the equilibrium price and quantity
We know from our previous analysis that a decrease in demand and a decrease in supply will both decrease the quantity. A simultaneous decrease in both demand and supply will therefore decrease the quantity, as demonstrated in the next diagram. As D decreases to D1 and S decreases to S1, the equilibrium quantity declines from Qe to Q1.
A decrease in demand and supply
However, what we cannot predict is what happens to the price. In the above diagram, the price is unchanged since the relative shift of the demand and supply curve is the same. They shifted by the same magnitude.
In the next two diagrams, the price either increases or decreases, depending on the relative shifts of the demand and supply curves.
A decrease in demand and an increase in supply decreases quantity and increases price
A decrease in demand and an increase in supply decreases quantity and decreases price
In figure on the left, the price increases from Pe to P1. This is because the relative shift of the supply curve was greater than that of the demand curve. The impact of a decrease in the supply, which increases the price, is greater than the impact of a decrease in demand, which decreases the price. The net effect is an increase in the price.
However, in figure on the right, the price decreases from Pe to P1. This is because the relative shift of the demand curve is now greater than that of the supply curve. The impact of a decrease in the demand, which decreases the price, is greater than the impact of a decrease in supply, which increases the price, and the net effect is a decrease in the price.
Watch the following video clip on a decrease in demand and an increase in supply:
Activity
Do the following activity:
During 1999, Mr Chang, an entrepreneur living in Hong Kong, saw an opportunity to make a profit by supplying chickens to the market in Hong Kong. He argued that the slaughtering of millions of chickens in Hong Kong because of bird flu was causing a shortage of chickens. By importing chickens from Japan he believed that he would be able to make a profit by selling them in Hong Kong where the shortage of chickens would cause the price of chickens to increase.
The following diagram represents the market for chickens before bird flu and the slaughtering of millions of chickens in Hong Kong:
Use this diagram to explain what the possible impact of the slaughtering of chickens would be on the market for chickens in Hong Kong.
There would be a change in a (demand factor; supply factor).
Think again. The slaughtering of chickens will impact the supply directly.
Correct. If will impact the supply of chickens.
There would be a(n) (decrease in demand; increase in demand; increase in supply; decrease in supply).
Think again. It is the supply that is affected.
Think again. It is the supply that is affected.
Think again. It will definitely not increase the supply.
Correct. It will cause a decrease in the supply of chickens.
The (demand curve; supply curve) would shift to the (right; left).
Think again. The impact is on the supply curve.
Correct. It is the supply curve that will shift.
Think again. It will cause a decrease in the supply of chickens.
Correct. The supply of chickens decreases and this is represented by a leftward shift of the supply curve for chickens.
An (excess demand; excess supply) would be created.
Correct. At the existing price and excess demand is created since the quantity demanded is less than the quantity supplied.
Think again. Due to the decrease in supply at the existing market price an excess demand is created since the quantity demanded is less than the quantity supplied.
Correct. Due to the excess demand the equilibrium price will rise.
Think again. Due to the excess demand the equilibrium price increases.
Think again. The supply has decreased and therefore the equilibrium quantity decreased.
Correct. The supply has decreased and therefore the equilibrium quantity decreased.
Unfortunately for Mr Chang, he did not make a profit because at the same time as chickens were being slaughtered, households' preference and taste for chickens declined drastically and the price for chickens declined.
The following diagram represents the market for chickens the before bird flu and the slaughtering of millions of chickens in Hong Kong:
Use the diagram to explain why Mr Chang did not make a profit by importing chickens from Japan and selling them in Hong Kong. For some questions, more than one choice may be correct.
There is a change in a (demand factor; supply factor).
Correct. Due to the decline in taste and preferences the demand for chickens changed.
Correct. Due to the slaughtering of chickens the supply of chickens changed.
There is a(n) (decrease in demand; increase in demand; increase in supply; decrease in supply).
Correct. The demand decreases due to the decline in tastes and preferences.
Think again. Tastes and preferences for chickens declined.
Think again. The slaughtering of the chickens caused a decrease in supply.
Correct. The slaughtering of chickens decreases the supply.
Correct. Since the price of chickens declined it implies that the leftward shift of the demand curve is greater than the leftward shift of the supply curve.
Think again. Since the price of chickens declined it implies that the leftward shift of the demand curve is greater than the leftward shift of the supply curve.