Changes in Demand and Supply

Change in either demand or supply will cause change in both price and quantity. Suppose people started seeing this headline everywhere: “Medical researchers discover that drinking coffee has immediate health benefits.” What do you expect would happen to the price and quantity of coffee that is exchanged in the market? The news might alter consumer tastes for coffee and lead to an increase in the demand for the drink. As demand increases, the quantity that consumers are willing and able to purchase at every price increases. Because coffee is relatively scarce and its producers face increasing marginal cost, the equilibrium price and quantity of coffee will rise in response to the increased demand.

What if Canada blocked all oil exports to the United States? How would that affect the market for gasoline? Canada is the largest exporter of oil to the United States, so this would definitely disrupt gasoline production. Decreased oil supplies would lead to a higher price and a lower quantity of oil. Because oil is the primary input of gasoline, the effect of higher oil prices would be to raise the cost of gasoline production. As the cost of production rises, producers supply less gasoline at every price in the market. Consumers, dutifully obeying the law of demand, are less willing to purchase gasoline as the price rises. The end result of the Canadian oil embargo would be to raise gasoline prices and reduce the quantity of gasoline sold.

It is easy to fall into the trap of attributing prices to “them.” “They” charge so much! “They” should lower prices! In a market, prices are determined by consumers and producers. If “you” would stop buying so much, “they” would charge less.

How does an economic recession affect the price of lobster? As unemployment increases, household incomes decrease. This decrease in income tends to reduce the demand for normal goods such as lobster, so at each and every price, consumers are not willing to buy as much as before. At these lower prices, many producers are unable to profit, and as a result the price and quantity of lobster sold in the market decreases.

Technological innovation often leads to greater productivity and lower production costs. Consider Henry Ford's application of the assembly line to automobile production. Ford was able to offer more cars for sale at each price in the market because of this innovation. This, combined with consumers' willingness to purchase more at lower prices, or the law of demand, resulted in the equilibrium price of cars decreasing while the equilibrium quantity increased.

Expected prices affect both supply and demand. If both consumers and producers expect home prices to decrease in the future, consumer demand decreases and producer supply increases. Consumers will now wait for the lower prices to materialize and hold off on making immediate purchases. Producers or sellers will seek to unload their inventory now while prices are still high. The combined result of this expected price decrease is a price decrease. Self-fulfilling prophecy is at work. What about quantity? Without knowing the actual values, you are unable to accurately predict what will happen to quantity. Supply and demand as presented allows you to estimate whether prices and quantities are going up or down, but without actual numbers, it is difficult to predict outcomes when supply and demand simultaneously change.

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