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 Changes in Equilibrium

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Table of contents

    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 studysmarterFig 1. - A leftward shift in Demand

    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

    What does change in equilibrium mean?

    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.

    How do changes in demand impact 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.

    Do changes in the equilibrium affect interest rate?

    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.

    What are examples of change in equilibrium in economics?

    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 do you calculate the changes in equilibrium?

    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.

    Test your knowledge with multiple choice flashcards

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

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

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

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