An Approach To Analyse Changes In Demand And Supply

After you have worked through this section of the learning unit, you should be able to:

  • explain the different steps that are followed when analysing a change in demand

In explaining the impact of an increase in income on equilibrium price and equilibrium quantity, we follow certain steps. Look at the scenario in the diagram below. As an economist, how will this situation impact the market for fried chicken pieces?

Click on your choice:

Step 1: Decide whether we are dealing with a supply or demand factor.

In the scenario above is the political rally a supply or demand factor with respect to the market for fried chicken pieces?

In this scenario, the number of people attending the political rally will influence the demand for food, including fried chicken pieces, so it is a demand factor that we were dealing with.

Step 2: Ask the question whether this is an increase or decrease in demand.

In this scenario, the number of people attending the political rally will increase the demand for fried chicken pieces.

Step 3: Determine whether the demand curve will shift to the left or to the right

In scenario, we determined that we were dealing with an increase in demand, which is represented by a rightward shift of the demand curve.

Step 4: Compare the new equilibrium position with the old one. Does the new equilibrium position indicate in an increase or a decrease in the equilibrium price and euilibrium quantity?

In this scenario we were able to show that the increase in demand, due to an increase in the number of buyers, caused an increase in the equilibrium price and the equilibrium quantity.

Graphically the above analysis can be represented as follows:

An increase in demand

This is known as a comparative static analysis since we are comparing two equilibrium positions – the initial equilibrium position E with the new equilibrium position E1.

Then we add some dynamics to our analysis by explaining how this new equilibrium position is reached.

We do this by showing how the increase in demand caused an excess demand or shortage in the market, which results in an increase in the price. The effect of this increase in price is that it encourages suppliers to increase the quantity supplied. At the same time, the increase in the price convinces buyers to decrease their quantity demanded. The combined effect is that the excess demand or shortage shrinks. This process continues until a new market equilibrium position is reached.

See the following video clip on the approach to analyse changes in demand and supply.