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Changes in Equilibrium

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Changes in Equilibrium

Where do prices come from? How does the market settle on how much of a good to supply? Prices in the market undergo a struggle between supply and demand until they finally settle at a balance, however that balance can be interrupted. Prices are determined by various combinations of economic factors at play, which dictates the optimal price level for each market. What happens when these factors fluctuate? How do such changes affect market prices? Read this explanation before the equilibrium changes again!

Changes in Equilibrium: Definition

Equilibrium is the point where there is no shortage or surplus. It is determined by the intersection between supply and demand, so that quantity demanded equals quantity supplied. In turn, this intersection corresponds to a certain price, which is the most efficient price that the market will thrive toward. If the market is out of equilibrium, it'll create a shortage or surplus which drives prices towards equilibrium.

Changes in various economic conditions and events can affect supply and demand, but what does this mean for the equilibrium? Market equilibrium is subject to the effect of fluctuations in market conditions and may respond to changes accordingly.

When changes in economic factors affect the state of the market, variables such as quantity supplied and demand may change in response. Changes in these variables will in turn shift the price level at which the market may stabilize, consequently resulting in supply and demand balancing out at a new point of equilibrium.

For changes in equilibrium consider commonplace things that affect the market and actors within the market. This could be inflation, gas prices affecting transportation costs, increase in income, stimulus checks from the government, shortage of materials, or trade restrictions. We can analyze the effects of changes using the four-step process below:

Step 1: Sketch a supply and demand model of the market at equilibrium. The demand is downward sloping, as price decreases, a higher quantity is demanded. The supply line is upward sloping as producers are willing to provide a high quantity at a high price. If specific data are provided, use them to determine the equilibrium quantity and price.

Step 2: The event that took place affects the market, but does it alter demand or supply? Or even both? Consider whether the event will alter the producers or consumers' behavior.

Step 3: Now that you know whether it affects supply or demand, we need to determine if it increases or decreases the affected segment. If it is an increase, it will shift the affected segment(s) to the right, and conversely, if it is a decrease it will shift the segment(s) to the left. Draw a new supply or demand line with the appropriate change, and only change both lines if both are affected by the market event.

Step 4: Find the new intersection of supply and demand after the change. This is the new equilibrium. Identify the new equilibrium price and quantity. Compare this with the previous equilibrium to measure the total change in the market.

Equilibrium is the state of the market in which quantity demanded equals quantity supplied, thus stabilizing at the corresponding market price. Just like quantities demanded/supplied and price, equilibrium is subject to change.

Changes in Market Equilibrium

There are many factors that can affect a market's equilibrium. Consider this example below to understand how it shifts the market.

Suppose that due to a temporary economic downturn, average income sees a significant decrease. A decrease in consumers' income means that demand for some normal goods will decrease. Normal goods are products and services that are demanded in higher quantities when consumers' income rises; inversely, these goods will experience lower demand when consumers' income falls. Examples of normal goods include clothes, taxis, food staples, and electronics. Let us use taxi services for this step-by-step example of analyzing a change in market equilibrium.

changes in equilibrium leftward shift demand studysmarterFigure 1. A leftward shift in Demand, StudySmarter Originals

Step 1: Use Figure 1 provided above as your diagram for this example. Here, the initial position of the demand curve is (D1), the position of the demand curve is (D2) after accounting for the change in the market, the initial equilibrium occurs at the quantity (Q1) and price (P1), and the new equilibrium quantity is (Q2) and price (P2) after the change.

Step 2: Change in consumers' income is one of the factors that can cause shifts in demand. Due to a decrease in consumer income, the number of taxis demanded decreases as well.

Step 3: Since consumer income decreases in this example, the demand curve for taxis will shift leftward.

Step 4: With this leftward shift in demand (D1 to D2), the number of taxis demanded decreases (from Q1 to Q2), as illustrated in Figure 1 provided above. The demand curve after the shift now intersects the supply curve at a different point (E2) that, in turn, corresponds to a lower price (P2). Thus, the new equilibrium is now at a lower quantity (Q2) and lower price (P2), which now marks the new point at which the market can stabilize after the changes in outside economic factors.

In the example above we see that a decrease in income results in a shift in demand which changes a market to a new equilibrium. Economists who study this data can use it to guide business strategy in accordance with this change in the market. Demand for taxis decreases because income decreases, so how can firms use this information? They can allocate resources to goods and services that work better for lower-income individuals. This could be investing in public transit such as buses and trains. The private sector can respond by adding more rental scooters and bicycles as many US cities are already seeing.

Changes in Supply & Demand and their Effects on Equilibrium

As the supply and demand curves shift, the equilibrium point will shift as well. Thus, changes in supply and demand that lead either of the curves to shift will lead to changes in equilibrium. Changes in the market often affect both price and quantity as the two are linked. Elasticity describes how linked they are. When the market is at equilibrium, many consumers and producers obtain value from the efficiency of the competitive market. This is called consumer and producer surplus. Whenever something causes the equilibrium to deviate, the total economic surplus will change.

Learn more about what factors may lead to shifts in the supply and demand curves in our explanations of Shifts in Supply and Shifts in Demand.

Change in Equilibrium Quantity

While tied to price, there are other factors that alter the quantity demanded or supplied in a market. A common demand factor is changes in income, while a supply factor could be global supply chain issues as the pandemic revealed.

The federal government raises the national minimum wage to $15. Consumers now have more income which increases demand, shifting the curve right. Consumers will demand more goods and are willing to pay slightly more, so producers recognize this and increase supply. The net result is an increase in price and quantity.

It's important to consider that the market will naturally balance itself, meaning that when change occurs in one area, the whole market is likely to shift to a new balance. This means it can be difficult to control – as the example shows, the minimum wage was increased, but as a result, so did prices. To know if the wage increases actually made anyone's life better would require comparisons of living costs.

Change in Equilibrium Price

There is a multitude of factors that affect a market and alter the equilibrium price. Demand factors that can change price range from changes in income or preferences, while supply factors can be taxes or production costs changes.

Many firms have to restructure their finances after a minimum wage increase. It now costs more in labor to produce the same product. Firms pass this cost on to consumers by raising prices. The market response to raising prices is a drop in demand.

Now wait a minute, don't those two recent examples contradict each other? To some degree, yes – they did minimize the changes mentioned. That is the balancing aspect of the market, it's true that an increase in income raises consumers buying power, and it's also true that the increase in income raises supply costs. Each good may vary on whether consumers benefit from the income increase or the benefit is negated by the cost increase. Let's consider the debate of zero-sum vs positive-sum below.

Zero-Sum Theory vs Positive Sum and Multipliers

A common economic debate is whether the existence of zero-sum theory permeates our lives. Zero-sum means that for anyone to have more, someone else must have less. In this mindset, giving assistance to low-income workers will only drive prices up and negate any gains made by the change.The opposite belief is that the value an individual gain increases the value of others. If you purchase a good from the store, that store owner can in turn take the profit from your sale and buy something. This means that spending $10 allows another person to spend $2 more so $10 created $12 of market transactions.

Adjustment of Equilibrium in Real Markets

The whole world is interconnected. This is the same for markets of any scale – consider the widespread impact of a change in gas prices. Consumers that drive will have a decrease in pay, as it cost more to drive to work. Additionally, demand may decrease as it's expensive to drive to stores. Non-petroleum producers will experience an increase in shipping and transportation costs, requiring them to raise prices. Intermediary gas vendors will seek new manufacturers to buy from, raising global supply prices. New mining ventures will occur to increase the supply and cash in on the higher prices. The list goes on, global markets are a complex web holding the world together.

Given that supply, demand, and other market factors are subject to changes and fluctuations, it follows that equilibrium may shift accordingly. A change in equilibrium can provide us with valuable information about the behavior and trends in the market, as well as point to changes in the economic environment.

Changes in Equilibrium - Key takeaways

  • Equilibrium is the state of balance in the market in which quantity demanded equals quantity supplied. At the equilibrium price, there is no surplus or shortage.
  • Market equilibrium price can be used to determine a business strategy by identifying a market's profitability and where decision-makers can invest their resources.
  • To identify a change in equilibrium, determine whether a change in economic conditions affects supply or demand and whether the change causes a leftward or rightward shift.
  • After a change is accounted for by shifting either the demand or supply curve, the new point of equilibrium can be found at the new point of intersection between the supply and demand curves.
  • Market events that change the equilibrium will disrupt the competitive efficiency achieved potentially, changing supply, demand, consumer surplus, and producer surplus. Severity depends on the elasticity of the market.

Frequently Asked Questions about Changes in Equilibrium

Changes in equilibrium occur when a change in one or more economic factors shift the supply or demand curve, thus shifting the point of intersection between the two curves. This translates into the new market equilibrium.

The quantity demanded can either decrease (demand curve shifting leftward) or increase (shifting rightward). If the demand curve shifts leftward, the new equilibrium will be at a lower quantity and price. If the demand curve shifts rightward, the new equilibrium will be at a higher quantity and price.

Changes in equilibrium do affect the interest rate. The market for loanable funds is similar to most market structures. It has supply and demand and an equilibrium interest rate where they are equal to each other. Changes in equilibrium can either decrease or increase investment, and changes can also be implemented by the Federal Reserve.

Suppose that consumers expect real estate prices to fall drastically in the future, and thus currently hold off on purchasing properties. This means that quantity demanded will shift leftward and so will the demand curve. In turn, this will result in the new equilibrium stabilizing at a lower quantity and price.

How to calculate the changes in equilibrium: To calculate a change in equilibrium compare the original market equilibrium to the newly calculated equilibrium. Measure the change in price and quantity as a percentage of the original.

Final Changes in Equilibrium Quiz

Question

What is equilibrium?

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Answer

Equilibrium is the point of intersection between the supply and demand curves, where quantity supplied equals quantity demanded, thus balancing the market at the corresponding market price.

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Question

What can cause a change in equilibrium on a supply and demand graph?

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Answer

A change in the point of equilibrium can be a result of either the supply or demand curve shifting leftward or rightward.

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Does a change in the price that a service or product is supplied at cause a change in equilibrium in the short run?

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Answer

No, a new equilibrium can only be reached when either of the curves shift in response to changes in economic factors.

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Question

If the demand curve shifts leftwards, the new equilibrium price will be...

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Answer

Lower

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If the supply curve shifts leftwards, the new equilibrium quantity will be...

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Lower

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Which of the following factors could cause a change in equilibrium by shifting the supply curve?

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Change in input prices

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Does a change in market price alone without a change in quantity change the point of equilibrium?

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Answer

No. A change in price alone would create a shortage or a surplus, but would not change the equilibrium.

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Question

How can using the supply and demand model help with identifying a change in equilibrium?

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Answer

By using the supply and demand model, you can draw the supply and demand curves before and after the shift, thus visualizing where and by how much the point of equilibrium shifts.

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Question

What is the primary factor that determines the impact of the change in the market leading to a change in equilibrium?

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Answer

Price elasticity of supply and demand

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Question

Suppose that steel prices have drastically increased. Given the impact that this change would have on car producers, how would it impact the equilibrium in the car market?

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Answer

Since the supply curve would shift leftward, the point of equilibrium would shift leftward by increasing in price and decreasing in quantity.

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How would an increase in demand generally impact the equilibrium point in a market?

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The equilibrium quantity and price would both increase.

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How would an increase in supply generally impact the point of equilibrium in a market?

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Answer

The equilibrium quantity would increase and the equilibrium price would decrease.

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Suppose that denim skirts become significantly more popular. How would this increase in demand impact the equilibrium?

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Answer

Both the equilibrium quantity and price would increase.

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How would the point of equilibrium change in response to a decrease in supply?

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Answer

The equilibrium quantity would decrease and price would increase.

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Question

Suppose you graph a change in equilibrium that occurred due to a shift of the demand curve. Based on your graph, how would you measure the change in equilibrium quantity?

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Answer

The change in equilibrium quantity is equivalent to the difference between the initial equilibrium quantity and the equilibrium quantity after the change.

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Question

Equilibrium is the point where ....

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there is no shortage or surplus

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Question

What is the name of the products and services that are demanded in higher quantities when consumers' income rises?

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Answer

Normal goods

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Question

Highlight the incorrect portion of the text:


Normal goods will experience lower demand when consumers' income increases.

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Answer

Normal goods 

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After a change is accounted for by shifting either the demand or supply curve, the new point of equilibrium can be found at the new point of intersection between the...

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Answer

supply and demand curves.

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Fill the blanks:

Market events that change the equilibrium will disrupt the competitive efficiency achieved potentially, changing supply, ..., consumer surplus, and ... surplus.

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Answer

demand/producer

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Give an example of the allocation of resources to goods and services that work better for lower-income individuals.

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Answer

This could be investing in public transit such as buses and trains

Show question

Question

How do fluctuations in market conditions affect the market equilibrium?

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Answer

Market equilibrium is subject to the effect of fluctuations in market conditions and may respond to changes accordingly.

Show question

Question

Which of the following is not correct about sketching a supply and demand model?

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Answer

the demand is upward sloping

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Question

Suppose that due to a temporary economic downturn, average income sees a significant decrease. What does a decrease in consumers' income mean for some normal goods? 

Show answer

Answer

 A decrease in consumers' income means that demand for some normal goods will decrease.

Show question

Question

Normal goods are products and services that are demanded in higher quantities ...

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Answer

... when consumers' income rises

Show question

Question

Give examples of normal goods.

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Answer

Examples of normal goods include clothes, taxis, food staples, and electronics.

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Question

Changes in the market often affect both price and quantity as the two are linked.  

Which economic term is used to describe 

how linked they are?

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Answer

Elasticity describes how linked they are

Show question

Question

When the market is at equilibrium, many consumers and producers obtain value from the efficiency of the competitive market. This is called ...

Show answer

Answer

consumer and producer surplus

Show question

Question

Let's say the federal government raises the national minimum wage. Consumers now have more income which increases demand, shifting the curve right. Consumers will demand more goods and are willing to pay slightly more, so producers recognize this and increase supply. What is the net result?

Show answer

Answer

The net result is an increase in price and quantity.

Show question

Question

What does zero-sum mean?

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Answer

Zero-sum means that for anyone to have more, someone else must have less.

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