The Adjustment Process

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

  • illustrate and explain the adjustment process in a market if demand increases

From the above analysis we know what the end result of an increase in income on the equilibrium price and equilibrium quantity in the market for fried chicken pieces is. It increases both the equilibrium price and equilibrium quantity. What we have not yet done is to explain the adjustment process from the initial equilibrium, E, to the new equilibrium, E1.

We will now see what this adjustment process is all about when demand increases.

Excess demand is created

At the initial equilibrium position, E, with a price of R4, the increase in demand creates excess demand or a shortage. At this price of R4, the quantity demanded is 5 400, while the quantity supplied is 3 000. There is thus excess demand of 2 400.

An increase in demand creates an excess demand

An increase in demand creates an excess demand

An increase in demand creates an excess demand

An increase in demand creates an excess demand

An increase in demand creates an excess demand

An increase in demand creates an excess demand

The market is now in disequilibrium because consumers cannot obtain the quantity they plan to buy at a price of R4. This disequilibrium will lead to changes in the market that will result in a new equilibrium.

The following diagram illustrates the impact of an increase in demand. Study the diagram and answer the questions.

  1. Before the increase in demand, the equilibrium price is _____ and the equilibrium quantity is _______.
  2. Owing to an increase in demand, the demand curve shifts from D to D1. At a price of R10, after the increase in demand, the quantity demanded is _______ and the quantity supplied is ______.
  3. At a price of R10, after the increase in demand, there is an (excess demand; excess supply).
Click to see the answer
  1. Before the increase in demand, the equilibrium price is R10 and the equilibrium
    quantity is 900.
  2. Owing to an increase in demand, the demand curve shifts from D to D1. At a price of R10, after the increase in demand, the quantity demanded is 1 300 and the quantity supplied is 900.
  3. At a price of R10, after the increase in demand, there is an excess demand.

From excess demand to new equilibrium

As indicated, at R4, an excess demand exists since at R4 consumers demand a quantity of 5 400, while the suppliers are only willing to supply a quantity of 3 000.

As you know, excess demand will force buyers to offer suppliers a higher price to encourage them to offer a higher quantity. And as long as there is excess demand, the price of the good will rise. A rise in the price of the good not only causes an increase in the quantity supplied, but is also results in a decrease in the quantity demanded.

An excess demand causes an increase in the price

An increase in demand creates an excess demand

An increase in demand creates an excess demand

An increase in demand creates an excess demand

An increase in demand creates an excess demand

An increase in demand creates an excess demand

An increase in demand creates an excess demand

An increase in demand creates an excess demand

An increase in demand creates an excess demand

Consider an increase in the price from R4 to R5. When the price increases to R5, two things happen in the market: the quantity demanded decreases from 5 400 to 4 800, while the quantity supplied increases from 3 000 to 3 600 pieces and the excess demand starts to decrease. The increase in price is encouraging suppliers to increase the quantity supplied and discouraging buyers, which decreases their quantity demanded. The combined effect of this is that the excess demand or shortage decreases.

This trend will continue until a position is reached where the quantity demanded is equal to the quantity supplied – the new equilibrium position where the equilibrium price is R6 and the equilibrium quantity is 4 200.

The result of an increase in demand is that both the equilibrium price and the equilibrium quantity rise.

↑Demand → Excess demand (Qd > Qs) → ↑Pe → ↑Qe

An increase in demand causes an excess demand since the quantity demanded is greater than the quantity supplied. This excess demand leads to an increase in the price, and the end result is that both the equilibrium price and the equilibrium quantity increase.

Watch the following video clip on the adjustment process if demand increases.

Activity

Do the following activity to see if you understand the impact of an increase in demand:

The following diagram illustrates the impact of an increase in demand. Study the diagram and answer the questions.

  1. An excess demand at a price of R10 will lead to (a decrease in the price; an increase in the price).
  2. At a price such as R11, the quantity supplied is ______ and the quantity demanded is ________and an (excess demand; excess supply) exists at this price.
  3. As long as an excess demand exists, the price will (increase; decrease).
  4. A new equilibrium position is formed after the increase in demand at an equilibrium price of ______ and an equilibrium quantity of ______.
Click to see the answer
  1. An excess demand at a price such as R10 will lead to an increase in the price.
  2. At a price such as R11, the quantity supplied is 1 000 and the quantity demanded is 1 200 and an excess demand exists at this price.
  3. As long as an excess demand exists, the price will increase.
  4. A new equilibrium position is formed after the increase in demand at an equilibrium price of R12 and an equilibrium quantity of 1 100.

Arrange the following elements to show the chain of events that occurs for an increase in demand:

  • ↑P
  • ↑Demand
  • Qd >Qs (excess demand)
  • ↑Q
Click to see the answer

The correct sequence is ↑Demand → Qd >Qs (excess demand) → ↑P and ↑Q