## Demand, Supply, and Equilibrium

Read this section on the Circular Flow of Economic Activity. Learn about the how the circular flow model provides a link between the demand and supply in the product and factor markets.

### Demand, Supply, and Equilibrium

#### Shifts in Demand and Supply

Figure 3.10 Changes in Demand and Supply

A change in demand or in supply changes the equilibrium solution in the model. Panels (a) and (b) show an increase and a decrease in demand, respectively; Panels (c) and (d) show an increase and a decrease in supply, respectively.

A change in one of the variables (shifters) held constant in any model of demand and supply will create a change in demand or supply. A shift in a demand or supply curve changes the equilibrium price and equilibrium quantity for a good or service. Figure 3.10 "Changes in Demand and Supply" combines the information about changes in the demand and supply of coffee presented in Figure 3.2 "An Increase in Demand", Figure 3.3 "A Reduction in Demand", Figure 3.5 "An Increase in Supply", and Figure 3.6 "A Reduction in Supply" In each case, the original equilibrium price is $6 per pound, and the corresponding equilibrium quantity is 25 million pounds of coffee per month. Figure 3.10 "Changes in Demand and Supply" shows what happens with an increase in demand, a reduction in demand, an increase in supply, and a reduction in supply. We then look at what happens if both curves shift simultaneously. Each of these possibilities is discussed in turn below. #### An Increase in Demand An increase in demand for coffee shifts the demand curve to the right, as shown in Panel (a) of Figure 3.10 "Changes in Demand and Supply". The equilibrium price rises to$7 per pound. As the price rises to the new equilibrium level, the quantity supplied increases to 30 million pounds of coffee per month. Notice that the supply curve does not shift; rather, there is a movement along the supply curve.

Demand shifters that could cause an increase in demand include a shift in preferences that leads to greater coffee consumption; a lower price for a complement to coffee, such as doughnuts; a higher price for a substitute for coffee, such as tea; an increase in income; and an increase in population. A change in buyer expectations, perhaps due to predictions of bad weather lowering expected yields on coffee plants and increasing future coffee prices, could also increase current demand.

Panel (b) of Figure 3.10 "Changes in Demand and Supply" shows that a decrease in demand shifts the demand curve to the left. The equilibrium price falls to $5 per pound. As the price falls to the new equilibrium level, the quantity supplied decreases to 20 million pounds of coffee per month. Demand shifters that could reduce the demand for coffee include a shift in preferences that makes people want to consume less coffee; an increase in the price of a complement, such as doughnuts; a reduction in the price of a substitute, such as tea; a reduction in income; a reduction in population; and a change in buyer expectations that leads people to expect lower prices for coffee in the future. #### An Increase in Supply An increase in the supply of coffee shifts the supply curve to the right, as shown in Panel (c) of Figure 3.10 "Changes in Demand and Supply". The equilibrium price falls to$5 per pound. As the price falls to the new equilibrium level, the quantity of coffee demanded increases to 30 million pounds of coffee per month. Notice that the demand curve does not shift; rather, there is movement along the demand curve.

Possible supply shifters that could increase supply include a reduction in the price of an input such as labor, a decline in the returns available from alternative uses of the inputs that produce coffee, an improvement in the technology of coffee production, good weather, and an increase in the number of coffee-producing firms.

#### A Decrease in Supply

Panel (d) of Figure 3.10 "Changes in Demand and Supply" shows that a decrease in supply shifts the supply curve to the left. The equilibrium price rises to \$7 per pound. As the price rises to the new equilibrium level, the quantity demanded decreases to 20 million pounds of coffee per month.

Possible supply shifters that could reduce supply include an increase in the prices of inputs used in the production of coffee, an increase in the returns available from alternative uses of these inputs, a decline in production because of problems in technology (perhaps caused by a restriction on pesticides used to protect coffee beans), a reduction in the number of coffee-producing firms, or a natural event, such as excessive rain.