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Micro Economics

Khan Academy
5/28/2019

Nadir
Contents
Law of demand ......................................................................................................................................... 3
Key points ................................................................................................................................................. 3
Demand for goods and services ................................................................................................................ 3
Demand schedule and demand curve ........................................................................................................ 3
The difference between demand and quantity demanded ......................................................................... 5
What factors change demand? ................................................................................................................ 7
Key points ................................................................................................................................................. 7
What factors affect demand?..................................................................................................................... 7
The ceteris paribus assumption ................................................................................................................. 7
How does income affect demand? ............................................................................................................ 8
Normal and inferior goods .................................................................................................................. 10
Other factors that shift demand curves ................................................................................................... 10
Changing tastes or preferences ........................................................................................................... 10
Changes in the composition of the population .................................................................................... 11
Related goods ...................................................................................................................................... 11
Changes in expectations about future prices or other factors that affect demand ............................... 12
Summing up factors that change demand ............................................................................................... 12
Law of supply ............................................................................................................................................ 14
Key points ............................................................................................................................................... 14
Supply of goods and services .................................................................................................................. 14
Supply schedule and supply curve .......................................................................................................... 14
The difference between supply and quantity supplied ............................................................................ 16
What factors change supply? ................................................................................................................. 17
Key points ............................................................................................................................................... 17
The ceteris paribus assumption ............................................................................................................... 17
How production costs affect supply ........................................................................................................ 17
Other factors that affect supply ............................................................................................................... 19
Natural conditions ............................................................................................................................... 19
New technology .................................................................................................................................. 19
Government policies ........................................................................................................................... 20
Summing up factors that change supply ................................................................................................. 20

1
Market equilibrium .................................................................................................................................... 22
Key points ............................................................................................................................................... 22
Where demand and supply intersect ....................................................................................................... 22
Changes in equilibrium price and quantity: the four-step process.................................................... 25
Key points ............................................................................................................................................... 25
Changes in equilibrium price and quantity: the four-step process .......................................................... 25
Shift in supply: good weather for salmon fishing ................................................................................... 26
Shift in demand: newspapers and the internet......................................................................................... 29
A combined example: the US Postal Service.......................................................................................... 31
Analysis of increase in postal worker compensation .......................................................................... 33
Analysis of increase in use of digital communication ........................................................................ 33
Summary ................................................................................................................................................. 37
Self-check questions ............................................................................................................................... 38
Review questions .................................................................................................................................... 38
Critical-thinking questions ...................................................................................................................... 39
Practice problems ........................................................................................................................ 39

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Law of demand
Key points

 The law of demand states that a higher price leads to a lower quantity demanded and that a
lower price leads to a higher quantity demanded.
 Demand curves and demand schedules are tools used to summarize the relationship between
quantity demanded and price.

Demand for goods and services

Economists use the term demand to refer to the amount of some good or service consumers are
willing and able to purchase at each price. Demand is based on needs and wants—a consumer
may be able to differentiate between a need and a want, but from an economist’s perspective
they are the same thing. Demand is also based on ability to pay. If you cannot pay, you have no
effective demand.

What a buyer pays for a unit of the specific good or service is called price. The total number of
units purchased at that price is called the quantity demanded. A rise in price of a good or
service almost always decreases the quantity demanded of that good or service. Conversely, a
fall in price will increase the quantity demanded. When the price of a gallon of gasoline goes up,
for example, people look for ways to reduce their consumption by combining several errands,
commuting by carpool or mass transit, or taking weekend or vacation trips closer to home.
Economists call this inverse relationship between price and quantity demanded the law of
demand. The law of demand assumes that all other variables that affect demand are held
constant.

Demand schedule and demand curve

 A demand schedule is a table that shows the quantity demanded at each price.

3
 A demand curve is a graph that shows the quantity demanded at each price.
Here's an example of a demand schedule from the market for gasoline.

Price (per gallon) Quantity demanded (millions of gallons)

\$1.00$1.00dollar sign, 1, point, 00 800800800

\$1.20$1.20dollar sign, 1, point, 20 700700700

\$1.40$1.40dollar sign, 1, point, 40 600600600

\$1.60$1.60dollar sign, 1, point, 60 550550550

\$1.80$1.80dollar sign, 1, point, 80 500500500

\$2.00$2.00dollar sign, 2, point, 00 460460460

\$2.20$2.20dollar sign, 2, point, 20 420420420

Price, in this case, is measured in dollars per gallon of gasoline. The quantity demanded is
measured in millions of gallons over some time period—for example, per day or per year—and
over some geographic area—like a state or a country.

Here's the same information shown as a demand curve with quantity on the horizontal axis and
the price per gallon on the vertical axis. Note that this is an exception to the normal rule in
mathematics that the independent variable (xxx) goes on the horizontal axis and the dependent
variable (yyy) goes on the vertical.

A Demand Curve for Gasoline

4
The graph shows a downward-sloping demand curve that represents the law of demand.

The demand schedule shows that as price rises, quantity demanded decreases, and vice versa.
These points are then graphed, and the line connecting them is the demand curve. The downward
slope of the demand curve again illustrates the law of demand—the inverse relationship between
prices and quantity demanded.

Demand curves will be somewhat different for each product. They may appear relatively steep or
flat, and they may be straight or curved. Nearly all demand curves share the fundamental
similarity that they slope down from left to right, embodying the law of demand: As the price
increases, the quantity demanded decreases, and, conversely, as the price decreases, the quantity
demanded increases.

[Attribution]

The difference between demand and quantity demanded

In economic terminology, demand is not the same as quantity demanded. When economists talk
about demand, they mean the relationship between a range of prices and the quantities demanded
at those prices, as illustrated by a demand curve or a demand schedule. When economists talk
about quantity demanded, they mean only a certain point on the demand curve or one quantity on

5
the demand schedule. In short, demand refers to the curve, and quantity demanded refers to a
specific point on the curve.

6
What factors change demand?
Key points

 Demand curves can shift. Changes in factors like average income and preferences can cause
an entire demand curve to shift right or left. This causes a higher or lower quantity to be
demanded at a given price.
 Ceteris paribus assumption. Demand curves relate the prices and quantities demanded
assuming no other factors change. This is called the ceteris paribus assumption. This article talks
about what happens when other factors aren't held constant.

What factors affect demand?

We defined demand as the amount of some product a consumer is willing and able to purchase at
each price. That suggests at least two factors in addition to price that affect demand. Willingness
to purchase suggests a desire, based on what economists call tastes and preferences. If you
neither need nor want something, you will not buy it. Ability to purchase suggests that income is
important. Professors are usually able to afford better housing and transportation than students
because they have more income. Prices of related goods can affect demand also. If you need a
new car, the price of a Honda may affect your demand for a Ford. Finally, the size or
composition of the population can affect demand. The more children a family has, the greater
their demand for clothing. The more driving-age children a family has, the greater their demand
for car insurance, and the less for diapers and baby formula.

The ceteris paribus assumption

A demand curve or a supply curve is a relationship between two, and only two, variables:
quantity on the horizontal axis and price on the vertical axis. The assumption behind a demand
curve or a supply curve is that no relevant economic factors, other than the product’s price, are
changing. Economists call this assumption ceteris paribus, a Latin phrase meaning “other things
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being equal”. If all else is not held equal, then the laws of supply and demand will not
necessarily hold. The rest of this article explores what happens when other factors aren't held
constant.

How does income affect demand?

Say we have an initial demand curve for a certain kind of car. Now imagine that the economy
expands in a way that raises the incomes of many people, making cars more affordable. This will
cause the demand curve to shift.

Which direction would this rise in incomes cause the demand curve to shift?

Choose 1 answer:

Choose 1 answer:


(Choice A)

Left


(Choice B)

Right

Check

Shifts in demand: a car example

8
The graph shows demand curve D sub 0 as the original demand curve. Demand curve D sub 1
represents a shift based on increased income. Demand curve D sub 2 represents a shift based on
decreased income.

As a result of the higher income levels, the demand curve shifts to the right, toward \text D_1D1
D, start subscript, 1, end subscript. People have more money on average, so they are more likely
to buy a car at a given price, increasing the quantity demanded.

A decrease in incomes would have the opposite effect, causing the demand curve to shift to the
left, toward \text D_2D2D, start subscript, 2, end subscript. People have less money on average,
so they are less likely to buy a car at a given price, decreasing the quantity demanded.

[What about shifting up and down?]

When a demand curve shifts, it does not mean that the quantity demanded by every individual
buyer changes by the same amount. In this example, not everyone would have higher or lower
income and not everyone would buy or not buy an additional car. Instead, a shift in a demand
curve captures a pattern for the market as a whole.

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Normal and inferior goods

A product whose demand rises when income rises, and vice versa, is called a normal good. A
few exceptions to this pattern do exist, though. As incomes rise, many people will buy fewer
generic-brand groceries and more name-brand groceries. They are less likely to buy used cars
and more likely to buy new cars. They will be less likely to rent an apartment and more likely to
own a home, and so on. A product whose demand falls when income rises, and vice versa, is
called an inferior good. In other words, when income increases, the demand curve shifts to the
left.

Other factors that shift demand curves

Income is not the only factor that causes a shift in demand. Other things that change demand
include tastes and preferences, the composition or size of the population, the prices of related
goods, and even expectations. A change in any one of the underlying factors that determine what
quantity people are willing to buy at a given price will cause a shift in demand. Graphically, the
new demand curve lies either to the right, an increase, or to the left, a decrease, of the original
demand curve. Let’s look at these factors.

Changing tastes or preferences

From 1980 to 2014, the per-person consumption of chicken by Americans rose from 48 pounds
per year to 85 pounds per year, and consumption of beef fell from 77 pounds per year to 54
pounds per year, according to the U.S. Department of Agriculture (USDA). Changes like these
are largely due to movements in taste, which change the quantity of a good demanded at every
price—that is, they shift the demand curve for that good, rightward for chicken and leftward for
beef.

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Changes in the composition of the population

The proportion of elderly citizens in the United States population is rising. It rose from 9.8% in
1970 to 12.6% in 2000 and is projected by the U.S. Census Bureau to be 20% of the population
by 2030. A society with relatively more children, like the United States in the 1960s, will have
greater demand for goods and services like tricycles and day care facilities. A society with
relatively more elderly persons, as the United States is projected to have by 2030, has a higher
demand for nursing homes and hearing aids. Similarly, changes in the size of the population can
affect the demand for housing and many other goods. Each of these changes in demand will be
shown as a shift in the demand curve.

Related goods

The demand for a product can also be affected by changes in the prices of related goods such as
substitutes or complements. A substitute is a good or service that can be used in place of another
good or service. As electronic resources, like this one, become more available, you would expect
to see a decrease in demand for traditional printed books. A lower price for a substitute decreases
demand for the other product. For example, in recent years as the price of tablet computers has
fallen, the quantity demanded has increased because of the law of demand. Since people are
purchasing tablets, there has been a decrease in demand for laptops, which can be shown
graphically as a leftward shift in the demand curve for laptops. A higher price for a substitute
good has the reverse effect.

Other goods are complements for each other, meaning that the goods are often used together
because consumption of one good tends to enhance consumption of the other. Examples include
breakfast cereal and milk; notebooks and pens or pencils; golf balls and golf clubs; gasoline and
sport utility vehicles; and the five-way combination of bacon, lettuce, tomato, mayonnaise, and
bread. If the price of golf clubs rises, the quantity demanded of golf clubs falls because of the
law of demand, and demand for a complement good like golf balls decreases along with it.

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Similarly, a higher price for skis would shift the demand curve for a complement good like ski
resort trips to the left, while a lower price for a complement has the reverse effect.

Changes in expectations about future prices or other factors that affect demand

While it is clear that the price of a good affects the quantity demanded, it is also true that
expectations about the future price—or expectations about tastes and preferences, income, and so
on—can affect demand. For example, if people hear that a hurricane is coming, they may rush to
the store to buy flashlight batteries and bottled water. If people learn that the price of a good like
coffee is likely to rise in the future, they may head for the store to stock up on coffee now. These
changes in demand are shown as shifts in the curve. Therefore, a shift in demand happens when a
change in some economic factor other than price causes a different quantity to be demanded at
every price.

Summing up factors that change demand

Six factors that can shift demand curves are summarized in the graph below. Notice that a
change in the price of the good or service itself is not listed among the factors that can shift a
demand curve. A change in the price of a good or service causes a movement along a specific
demand curve, and it typically leads to some change in the quantity demanded, but it does not
shift the demand curve.

Factors That Shift Demand Curves

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The graph on the left lists events that could lead to increased demand. The graph on the right lists
events that could lead to decreased demand.

(a) A list of factors that can cause an increase in demand from \text D_0D0D, start subscript, 0,
end subscript to \text D_1D1D, start subscript, 1, end subscript. (b) The same factors, if their
direction is reversed, can cause a decrease in demand from \text D_0D0D, start subscript, 0, end
subscript to \text D_1D1D, start subscript, 1, end subscript.

When a demand curve shifts, it will then intersect with a given supply curve at a different
equilibrium price and quantity. We are, however, getting ahead of our story. Before discussing
how changes in demand can affect equilibrium price and quantity, we first need to discuss shifts
in supply curves.

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Law of supply
Key points

 The law of supply states that a higher price leads to a higher quantity supplied and that a lower
price leads to a lower quantity supplied.
 Supply curves and supply schedules are tools used to summarize the relationship between
supply and price.

Supply of goods and services

When economists talk about supply, they mean the amount of some good or service a producer is
willing to supply at each price. Price is what the producer receives for selling one unit of a good
or service. A rise in price almost always leads to an increase in the quantity supplied of that good
or service, while a fall in price will decrease the quantity supplied. When the price of gasoline
rises, for example, it encourages profit-seeking firms to take several actions: expand exploration
for oil reserves, drill for more oil, invest in more pipelines and oil tankers to bring the oil to
plants where it can be refined into gasoline, build new oil refineries, purchase additional
pipelines and trucks to ship the gasoline to gas stations, and open more gas stations or keep
existing gas stations open longer hours. Economists call this positive relationship between price
and quantity supplied—that a higher price leads to a higher quantity supplied and a lower price
leads to a lower quantity supplied—the law of supply. The law of supply assumes that all other
variables that affect supply are held constant.

Supply schedule and supply curve

 A supply schedule is a table that shows the quantity supplied at each price.
 A supply curve is a graph that shows the quantity supplied at each price.
Here's an example of a supply schedule from the market for gasoline:

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Price (per gallon) Quantity supplied (millions of gallons)

\$1.00$1.00dollar sign, 1, point, 00 500500500

\$1.20$1.20dollar sign, 1, point, 20 550550550

\$1.40$1.40dollar sign, 1, point, 40 600600600

\$1.60$1.60dollar sign, 1, point, 60 640640640

\$1.80$1.80dollar sign, 1, point, 80 680680680

\$2.00$2.00dollar sign, 2, point, 00 700700700

\$2.20$2.20dollar sign, 2, point, 20 720720720

Price is measured in dollars per gallon of gasoline, and quantity supplied is measured in millions
of gallons.

Here's the same information shown as a supply curve with quantity on the horizontal axis and the
price per gallon on the vertical axis. Note that this is an exception to the normal rule in
mathematics that the independent variable goes on the horizontal axis and the dependent variable
goes on the vertical.

A supply curve for gasoline

15
The graph shows an upward-sloping supply curve that represents the law of supply.

The supply curve is created by graphing the points from the supply schedule and then connecting
them. The upward slope of the supply curve illustrates the law of supply—that a higher price
leads to a higher quantity supplied, and vice versa.

The shape of supply curves will vary somewhat according to the product: steeper, flatter,
straighter, or more curved. Nearly all supply curves, however, share a basic similarity: they slope
up from left to right and illustrate the law of supply. As the price rises, say, from 1 dollar per
gallon to 2.2 dollars per gallon, the quantity supplied increases from 500 million gallons to 720
million gallons. Conversely, as the price falls, the quantity supplied decreases.

The difference between supply and quantity supplied

In economic terminology, supply is not the same as quantity supplied. When economists refer to
supply, they mean the relationship between a range of prices and the quantities supplied at those
prices—a relationship that can be illustrated with a supply curve or a supply schedule. When
economists refer to quantity supplied, they mean only a certain point on the supply curve, or one
quantity on the supply schedule. In short, supply refers to the curve, and quantity supplied refers
to a specific point on the curve.

16
What factors change supply?
Key points

 Supply curve shift: Changes in production cost and related factors can cause an entire supply
curve to shift right or left. This causes a higher or lower quantity to be supplied at a given price.
 The ceteris paribus assumption: Supply curves relate prices and quantities supplied assuming
no other factors change. This is called the ceteris paribus assumption. This article talks about
what happens when other factors aren't held constant.

The ceteris paribus assumption

A demand curve or a supply curve is a relationship between two, and only two, variables:
quantity on the horizontal axis and price on the vertical axis. The assumption behind a demand
curve or a supply curve is that no relevant economic factors, other than the product’s price, are
changing. Economists call this assumption ceteris paribus, a Latin phrase meaning “other things
being equal”. If all else is not held equal, then the laws of supply and demand will not
necessarily hold. The rest of article talks about what happens when other factors aren't held
constant.

How production costs affect supply

A supply curve shows how quantity supplied will change as the price rises and falls, assuming
ceteris paribus—no other economically relevant factors are changing. If other factors relevant to
supply do change, then the entire supply curve will shift. A shift in supply means a change in the
quantity supplied at every price.

Say we have an initial supply curve for a certain kind of car. Now imagine that the price of
steel—an important ingredient in manufacturing cars—rises so that producing a car becomes
more expensive.

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Which direction would this rise in cost cause the supply curve to shift?

Choose 1 answer:

Choose 1 answer:


(Choice A)

Left


(Choice B)

Right

Check

Shifts in supply: a car example

18
The graph shows supply curve S sub 0 as the original supply curve. Supply curve S sub 1
represents a shift based on decreased supply. Supply curve S sub 2 represents a shift based on
increased supply.

As a result of the higher manufacturing costs, the supply curve shifts to the left, toward \text
S_1S1S, start subscript, 1, end subscript. Firms will profit less per car, so they are motivated
to make fewer cars at a given price, decreasing the quantity supplied.

A decrease in costs would have the opposite effect, causing the supply curve to shift to the right,
toward \text S_2S2S, start subscript, 2, end subscript. Firms would profit more per car, so they
would be motivated to make more cars at a given price, increasing the quantity supplied.

[What about shifting up and down?]

Other factors that affect supply

In the example above, we saw that changes in the prices of inputs in the production process will
affect the cost of production and thus the supply. Several other factors affect the cost of
production, too.

Natural conditions

In 2014, the Manchurian Plain in Northeastern China—which produces most of the country's
wheat, corn, and soybeans—experienced its most severe drought in 50 years. A drought
decreases the supply of agricultural products, which means that at any given price, a lower
quantity will be supplied. Conversely, especially good weather would shift the supply curve to
the right.

New technology

When a firm discovers a new technology that allows it to produce at a lower cost, the supply
curve will shift to the right as well. For instance, in the 1960s, a major scientific effort
nicknamed the Green Revolution focused on breeding improved seeds for basic crops like wheat
and rice. By the early 1990s, more than two-thirds of the wheat and rice in low-income countries

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around the world was grown with these Green Revolution seeds—and the harvest was twice as
high per acre. A technological improvement that reduces costs of production will shift supply to
the right, causing a greater quantity to be produced at any given price.

Government policies

Government policies can affect the cost of production and the supply curve through taxes,
regulations, and subsidies. For example, the U.S. government imposes a tax on alcoholic
beverages that collects about $8 billion per year from producers. Taxes are treated as costs by
businesses. Higher costs decrease supply for the reasons discussed above. Another example of
policy that can affect cost is the wide array of government regulations that require firms to spend
money to provide a cleaner environment or a safer workplace; complying with regulations
increases costs.

A government subsidy, on the other hand, is the opposite of a tax. A subsidy occurs when the
government pays a firm directly or reduces the firm’s taxes if the firm carries out certain actions.
From the firm’s perspective, taxes or regulations are an additional cost of production that shifts
supply to the left, leading the firm to produce a lower quantity at every given price. Government
subsidies, however, reduce the cost of production and increase supply at every given price,
shifting supply to the right.

Summing up factors that change supply

The graph below summarizes factors that change the supply of goods and services. Notice that a
change in the price of the product itself is not among the factors that shift the supply curve.
Although a change in price of a good or service typically causes a change in quantity supplied or
a movement along the supply curve for that specific good or service, it does not cause the supply
curve itself to shift.

Factors that shift supply curves

20
Two graphs—the graph on the left lists events that could lead to increased supply; the graph on
the right lists events that could lead to decreased supply.

(a) A list of factors that can cause an increase in supply from \text S_0S0S, start subscript, 0,
end subscript to \text S_1S1S, start subscript, 1, end subscript. (b) The same factors, if
their direction is reversed, can cause a decrease in supply from \text S_0S0S, start
subscript, 0, end subscript to \text S_1S1S, start subscript, 1, end subscript.

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Market equilibrium
Key points

 Supply and demand curves intersect at the equilibrium price. This is the price at which the
market will operate.

Where demand and supply intersect

Because the graphs for demand and supply curves both have price on the vertical axis and
quantity on the horizontal axis, the demand curve and supply curve for a particular good or
service can appear on the same graph. Together, demand and supply determine the price and the
quantity that will be bought and sold in a market.

Intersecting supply and demand curves

The graph shows the demand and supply for gasoline where the two curves intersect at the point
of equilibrium.

The demand curve, D, and the supply curve, S, intersect at the equilibrium point E, with
an equilibrium price of 1.4 dollars and an equilibrium quantityof 600. The equilibrium is the
only price where quantity demanded is equal to quantity supplied. At a price above equilibrium,
like 1.8 dollars, quantity supplied exceeds the quantity demanded, so there is excess supply. At a

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price below equilibrium, such as 1.2 dollars, quantity demanded exceeds quantity supplied, so
there is excess demand.

We can also find the equilibrium price by looking at a table.

Quantity supplied in Quantity demanded in


Price per gallon millions of gallons millions of gallons

\$1.00$1.00dollar sign, 1, point, 00 500500500 800800800

\$1.20$1.20dollar sign, 1, point, 20 550550550 700700700

\red {\$1.40}$1.40start color red, \red {600}600start color \red {600}600start color
dollar sign, 1, point, 40, end color red red, 600, end color red red, 600, end color red

\$1.60$1.60dollar sign, 1, point, 60 640640640 550550550

\$1.80$1.80dollar sign, 1, point, 80 680680680 500500500

\$2.00$2.00dollar sign, 2, point, 00 700700700 460460460

\$2.20$2.20dollar sign, 2, point, 20 720720720 420420420

The equilibrium price is the only price where the plans of consumers and the plans of producers
agree—that is, where the amount consumers want to buy of the product, quantity demanded, is
equal to the amount producers want to sell, quantity supplied. This common quantity is called
the equilibrium quantity. At any other price, the quantity demanded does not equal the quantity
supplied, so the market is not in equilibrium at that price.

The word equilibrium means balance. If a market is at its equilibrium price and quantity, then it
has no reason to move away from that point. However, if a market is not at equilibrium, then
economic pressures arise to move the market toward the equilibrium price and the equilibrium
quantity.

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Check out this video to see a discussion of how the interaction between supply and demand leads
to an equilibrium price.

24
Changes in equilibrium price and
quantity: the four-step process
Key points

 There is a four-step process that allows us to predict how an event will affect the equilibrium
price and quantity using the supply and demand framework.
 Step one of this process is to draw a demand and supply model representing the situation before
the economic event took place.
 Step two of this process is to decide whether the economic event being analyzed affects demand
or supply.
 Step three of this process is to decide whether the effect on demand or supply causes the curve to
shift to the right or to the left and to sketch the new demand or supply curve on the diagram.
 Step four of this process is to identify the new equilibrium and then compare the original
equilibrium price and quantity to the new equilibrium price and quantity.

Changes in equilibrium price and quantity: the four-step process

Let's start thinking about changes in equilibrium price and quantity by imagining a single event
has happened. It might be an event that affects demand—like a change in income, population,
tastes, prices of substitutes or complements, or expectations about future prices. Or, it might be
an event that affects supply—like a change in natural conditions, input prices, technology, or
government policies that affect production.

How do we know how an economic event will affect equilibrium price and quantity? Luckily,
there's a four-step process that can help us figure it out!

Step 1. Draw a demand and supply model representing the situation before the economic
event took place.

Establishing this model requires four standard pieces of information:

25
 The law of demand, which tells us the slope of the demand curve
 The law of supply, which gives us the slope of the supply curve
 The shift variables for demand
 The shift variables for supply.
Once you create your demand and supply model, you can use it to find the initial equilibrium
values for price and quantity.

Step 2. Decide whether the economic event being analyzed affects demand or supply.

In other words, does the event refer to something in the list of demand factors or supply factors?

Step 3. Decide whether the effect on demand or supply causes the curve to shift to the right
or to the left, and sketch the new demand or supply curve on the diagram.

You can think about it this way: Does the event change the amount consumers want to buy or the
amount producers want to sell?

Step 4. Identify the new equilibrium and then compare the original equilibrium price and
quantity to the new equilibrium price and quantity.

The best way to get at this process is to try it out a couple of times! Let’s first consider an
example that involves a shift in supply, then we'll move on to one that involves a shift in
demand. Finally, we'll consider an example where both supply and demand shift.

Shift in supply: good weather for salmon fishing

In the summer of 2000, weather conditions were excellent for commercial salmon fishing off the
California coast. Heavy rains meant higher than normal levels of water in the rivers, which
helped the salmon to breed. Slightly cooler ocean temperatures stimulated the growth of
plankton—the microscopic organisms at the bottom of the ocean food chain—providing
everything in the ocean with a hearty food supply. The ocean stayed calm during fishing season,
so commercial fishing operations did not lose many days to bad weather.

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How did these climate conditions affect the quantity and price of salmon? We can get to the
answer by working our way through the four-step process you learned above.

The demand and supply model and table below provide the information we need to get started!

The graph represents the four-step approach to determining shifts in the new equilibrium price
and quantity in response to good weather for salmon fishing.

Image credit: Figure 1 in "Changes in Equilibrium Price and Quantity: The Four-Step Process"
by OpenStaxCollege, CC BY 4.0

Price per Quantity supplied in Quantity supplied in Quantity


pound 1999 2000 demanded

$2.00 80 400 840

$2.25 120 480 680

$2.50 160 550 550

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Price per Quantity supplied in Quantity supplied in Quantity
pound 1999 2000 demanded

$2.75 200 600 450

$3.00 230 640 350

$3.25 250 670 250

$3.50 270 700 200

Salmon Fishing

Step 1. Draw a demand and supply model representing the situation before the economic
event took place.

In this example, our demand and supply model will illustrate the market for salmon in the year
before the good weather conditions began—you can see it above. The demand
curve \text{D0}D0D, 0 and the supply curve \text{S0}S0S, 0 show that the original equilibrium
price was $3.25 per pound and the original equilibrium quantity was 250,000 fish. This price per
pound is what commercial buyers pay at the fishing docks; what consumers pay at the grocery is
higher.

Step 2. Decide whether the economic event being analyzed affects demand or supply.

In our fishing example, good weather is an example of a natural condition that affects supply.

Step 3. Decide whether the effect on demand or supply causes the curve to shift to the right
or to the left, and sketch the new demand or supply curve on the diagram.

We need to determine if the the effect on supply in our example was an increase or a decrease.
Good weather is a change in natural conditions that increases the quantity supplied at any given
price. Because of this, the supply curve shifts to the right, moving from the original supply

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curve \text{S0}S0S, 0 to the new supply curve \text{S1}S1S, 1. You can see the shift in both the
demand and supply model and in the table.

Step 4. Identify the new equilibrium and then compare the original equilibrium price and
quantity to the new equilibrium price and quantity.

At the new equilibrium \text{E1}E1E, 1, the equilibrium price falls from $3.25 to $2.50, but the
equilibrium quantity increases from 250,000 to 550,000 salmon. Notice that the equilibrium
quantity demanded increased, even though the demand curve did not move.

What do those numbers mean exactly? In short, good weather conditions increased supply of the
California commercial salmon. The result was a higher equilibrium quantity of salmon bought
and sold in the market at a lower price.

Shift in demand: newspapers and the internet

According to the Pew Research Center for People and the Press, more and more people—
especially younger people—are getting their news from online and digital sources. The majority
of US adults now own smartphones or tablets, and most of those Americans say they use these
devices in part to get the news. From 2004 to 2012, the share of Americans who reported getting
their news from digital sources increased from 24% to 39%.

How has this shift in behavior affected consumption of print news media and radio and television
news?

Let's use our four-step process again to figure it out. You'll find all the info you need in the
demand and supply model below.

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The graph represents the four-step approach to determining changes in equilibrium price and
quantity of print news.

Image credit: Figure 2 in "Changes in Equilibrium Price and Quantity: The Four-Step Process"
by OpenStaxCollege, CC BY 4.0

Step 1. Draw a demand and supply model representing the situation before the economic
event took place.

In this case, we want our demand and supply model to represent the time before many
Americans began using digital and online sources for their news. You'll notice in this demand
and supply model—above—that the analysis was performed without specific numbers on the
price and quantity axes.

Step 2. Decide whether the economic event being analyzed affects demand or supply.

A change in tastes from traditional news sources—print, radio, and television—to digital sources
caused a change in demand for the former.

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Step 3. Decide whether the effect on demand or supply causes the curve to shift to the right
or to the left, and sketch the new demand or supply curve on the diagram.

A shift to digital news sources will tend to mean a lower quantity demanded of traditional news
sources at every given price, causing the demand curve for print and other traditional news
sources to shift to the left, from \text{D0}D0D, 0 to \text{D1}D1D, 1.

Step 4. Identify the new equilibrium and then compare the original equilibrium price and
quantity to the new equilibrium price and quantity.

The new equilibrium—\text{E1}E1E, 1—occurs at a lower quantity and a lower price than the
original equilibrium—\text{E0}E0E, 0.

So, what do we know now about the effect of the increased use of digital news sources? We
know—based on our four-step analysis—that fewer people desire traditional news sources, and
that these traditional news sources are being bought and sold at a lower price.

A combined example: the US Postal Service

In the real world, many factors affecting demand and supply can change all at once. For
example, more and more people are using email, text, and other digital message forms such as
Facebook and Twitter to communicate with friends and others, and at the same time,
compensation for postal workers tends to increase most years due to cost-of-living increases.

Additionally, an increase in the use of digital forms of communication will affect many markets,
not just the postal service. How can an economist sort out all these interconnected events? The
answer lies in the ceteris paribus—Latin for "other things equal"—assumption. We must look at
how each economic event affects each market, one event at a time, holding all else constant.
Then, we combine the analyses to see the net effect.

Let's use our four-step analysis to determine how the increased use of digital communication and
the increase in postal worker compensation will affect the viability of the Postal Service.

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This image has two panels—model A on the left and model B on the right. Model A shows the
four-step analysis of higher compensation for postal workers. Model B shows the four-step
analysis of a change in tastes away from postal services.

In model A, higher labor compensation causes a leftward shift in the supply curve, a decrease in
the equilibrium quantity, and an increase in the equilibrium price. In model B, a change in tastes
away from postal services causes a leftward shift in the demand curve, a decrease in the
equilibrium quantity, and a decrease in the equilibrium price.

Image credit: Figure 3 in "Changes in Equilibrium Price and Quantity: The Four-Step Process"
by OpenStaxCollege, CC BY 4.0

Since this problem involves two disturbances, we need two four-step analyses—the first to
analyze the effects of higher compensation for postal workers and the second to analyze the
effects of many people switching from "snail mail" to email and other digital messages.

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Analysis of increase in postal worker compensation

Step 1. Draw a demand and supply model representing the situation before the economic
event took place.

In this example, we want our demand and supply model to illustrate what the market looked like
before US postal worker compensation increased. The demand curve \text{D0}D0D, 0 and the
supply curve \text{S0}S0S, 0 in demand and supply model A—above left—show the original
relationships.

Step 2. Decide whether the economic event being analyzed affects demand or supply.

Labor compensation is a cost of production. A change in production costs causes a change


in supply for the postal services.

Step 3. Decide whether the effect on demand or supply causes the curve to shift to the right
or to the left, and sketch the new demand or supply curve on the diagram.

Higher labor compensation leads to a lower quantity supplied of postal services at every given
price, causing the supply curve for postal services to shift to the left, from \text{S0}S0S,
0 to \text{S1}S1S, 1.

Step 4. Identify the new equilibrium and then compare the original equilibrium price and
quantity to the new equilibrium price and quantity.

The new equilibrium—\text{E1}E1E, 1—occurs at a lower quantity and a higher price than the
original equilibrium—\text{E0}E0E, 0.

Analysis of increase in use of digital communication

Step 1. Draw a demand and supply model representing the situation before the economic
event took place.

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In this example, we want our demand and supply model to illustrate what the market looked like
before the use of digital communication increased. The demand curve \text{D0}D0D, 0 and the
supply curve \text{S0}S0S, 0 in demand and supply model B—above right—show the original
relationships. Note that demand and supply model B is independent from demand and supply
model A.

Step 2. Decide whether the economic event being analyzed affects demand or supply.

A change in tastes away from "snail mail" toward digital messages will cause a change
in demand for the Postal Service.

Step 3. Decide whether the effect on demand or supply causes the curve to shift to the right
or to the left, and sketch the new demand or supply curve on the diagram.

A shift to digital communication will tend to mean a lower quantity demanded of traditional
postal services at every given price, causing the demand curve for print and other traditional
news sources to shift to the left, from \text{D0}D0D, 0 to \text{D1}D1D, 1.

Step 4. Identify the new equilibrium and then compare the original equilibrium price and
quantity to the new equilibrium price and quantity. The new equilibrium—\text{E2}E2E,
2—occurs at a lower quantity and a lower price than the original equilibrium—\text{E0}E0E, 0.

The final step in a scenario where both supply and demand shift is to combine the two individual
analyses to determine what happens to the equilibrium quantity and price. One way to do this is
to graphically superimpose the two diagrams one on top of the other, as we've done below.

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The graph shows a leftward supply shift as well as a leftward demand shift.

Image credit: Figure 4 in "Changes in Equilibrium Price and Quantity: The Four-Step Process"
by OpenStaxCollege, CC BY 4.0

By examining the combined demand and supply model, we can come to the following
conclusions.

Effect on quantity: Higher postal worker labor compensation raises the cost of production of
postal services, which decreases the equilibrium quantity. A change in tastes away from "snail
mail" also decreases the equilibrium quantity. Since both shifts are to the left, the overall impact
is a decrease in the equilibrium quantity of postal services—\text{Q3}Q3Q, 3. We can see this
graphically since \text{Q3}Q3Q, 3 is to the left of \text{Q0}Q0Q, 0.

Effect on price: The overall effect on price is more complicated. Higher postal worker labor
compensation raises the cost of production, increasing the equilibrium price. But, a change in
tastes away from "snail mail" decreases the equilibrium price. Since the two effects are in
opposite directions, the overall effect is unclear, unless we know the magnitudes of the two
effects. But don't worry; we haven't done anything wrong! When both curves shift, typically we
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can determine the overall effect on price or on quantity, but not on both. In this case, we
determined the overall effect on the equilibrium quantity but not on the equilibrium price. In
other cases, it might be the opposite.

It's also important to keep in mind that economic events that affect equilibrium price and
quantity may seem to cause immediate change when examining them using the four-step
analysis. As a practical matter, however, prices and quantities often do not zoom straight to
equilibrium. More realistically, when an economic event causes demand or supply to shift, prices
and quantities set off in the general direction of equilibrium. Indeed, even as they are moving
toward one new equilibrium, prices are often then pushed by another change in demand or
supply toward another equilibrium.

And finally, a word of caution—one common mistake when analyzing the affects of an
economic event using the four-step system is to confuse shifts of demand or supply
with movements along a demand or supply curve.

[Learn how to avoid this common mistake.]

\text{S0}S, 0\text{S1}S, 1\text{E0}E, 0\text{E1}E, 1

\text{S1}S, 1\text{S2}S, 2\text{E1}E, 1\text{E2}E, 2

\text{D0}D, 0\text{D1}D, 1\text{E2}E, 2\text{E3}E, 3

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The graph shows the difference between shifts of demand and supply, and movement of demand
and supply. A shift in one curve never causes a shift in the other curve. Rather, a shift in one
curve causes a movement along the second curve.

Choose 1 answer:


(Choice A)


(Choice B)


(Choice C)

\text{D0}D, 0\text{E0}E, 0\text{E1}E, 1

Summary

When using the supply and demand framework to think about how an event will affect the
equilibrium price and quantity, proceed through four steps:

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Step 1. Draw a demand and supply model representing the situation before the economic event
took place.

Step 2. Decide whether the economic event being analyzed affects demand or supply.

Step 3. Decide whether the effect on demand or supply causes the curve to shift to the right or to
the left, and sketch the new demand or supply curve on the diagram.

Step 4. Identify the new equilibrium and then compare the original equilibrium price and
quantity to the new equilibrium price and quantity.

Self-check questions

From August 2014 to January 2015, the price of jet fuel decreased roughly 47%. Using the four-
step analysis, how do you think this fuel price decrease affected the equilibrium price and
quantity of air travel?

[Show solution.]

A tariff is a tax on imported goods. Suppose the US government cuts the tariff on imported
flatscreen televisions. Using the four-step analysis, how do you think the tariff reduction will
affect the equilibrium price and quantity of flatscreen TVs?

[Show solution.]

Review questions

 How can you analyze a market where both demand and supply shift?
 What causes a movement along the demand curve? What causes a movement along the supply
curve?

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Critical-thinking questions

 Use the four-step process to analyze the impact of the advent of the iPod and other portable
digital music players on the equilibrium price and quantity of the Sony Walkman and other
portable audio cassette players.
 Use the four-step process to analyze the impact of a reduction in tariffs on imports of iPods on
the equilibrium price and quantity of Sony Walkman-type products.
 Suppose both of these events took place at the same time. Combine your analyses of the impact
of the iPod and the impact of the tariff reduction to determine the likely combined impact on the
equilibrium price and quantity of Sony Walkman-type products. Show your answer graphically.

Practice problems

Problem 1: cheese

Demand and supply in the market for cheddar cheese is


illustrated in the table below. Graph the data and find the
equilibrium.

Next, create a table showing the change in quantity demanded or


quantity supplied and a graph of the new equilibrium in each of
the following situations:

 The price of milk, a key input for cheese production, rises so


that the supply decreases by 80 pounds at every price.
 A new study says that eating cheese is good for your health, so
demand increases by 20% at every price.

Price per pound Qd Qs

$3.00 750 540

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Price per pound Qd Qs

$3.20 700 600

$3.40 650 650

$3.60 620 700

$3.80 600 720

$4.00 590 730

Problem 2: movie tickets

Supply and demand for movie tickets in a city are shown in the
table below. Graph demand and supply and identify the
equilibrium. Then, calculate in a table and graph the effect of
the following two changes:

 Three new nightclubs open. They all offer decent bands and have
no cover charge, but they make their money by selling food and
drink. As a result, demand for movie tickets falls by 6 units at
every price.
 The city eliminates a tax that it had been placing on all local
entertainment businesses. The result is that the quantity
supplied of movies at any given price increases by 10%.

Price per ticket Qd Qs

$5.00 26 16

$6.00 24 18

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Price per ticket Qd Qs

$7.00 22 20

$8.00 21 21

$9.00 20 22

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