Causes of Price Changes: Shifts in Demand
→ Non-Price Factors of Demand → Causes the demand curve to shift left or right, disrupting initial market equilibrium
→ Increase in Demand → Demand curve shifts rightward (D1 to D2), causing a shortage at the original price
→ Price Impact → Price rises as consumers bid up prices to secure limited goods
→ Decrease in Demand → Demand curve shifts leftward (D1 to D2), creating a surplus at the original price
→ Price Impact → Price falls as producers discount stock to clear unsold inventory
Example:
→ A successful advertising campaign increases consumer preferences for organic food, shifting demand rightwards and raising its market price
Analysis:
→ Rightward Shift Process → Increase in demand → Shortage at initial price → Price increases → Extension along the supply curve to a higher equilibrium
→ Leftward Shift Process → Decrease in demand → Surplus at initial price → Price decreases → Contraction along the supply curve to a lower equilibrium
Evaluation:
→ The magnitude of price change depends on the price elasticity of supply (PES)
→ If supply is inelastic, a shift in demand causes a larger price change than when supply is elastic
Causes of Price Changes: Shifts in Supply
→ Non-Price Factors of Supply → Changes in production costs, technology, taxes, subsidies, or weather shift the supply curve
→ Increase in Supply → Supply curve shifts rightward (S1 to S2), creating a surplus at the original price
→ Price Impact → Price falls as firms compete to sell excess output
→ Decrease in Supply → Supply curve shifts leftward (S1 to S2), causing a shortage at the original price
→ Price Impact → Price rises due to scarcer availability of the product
Example:
→ A severe drought damages wheat crops, shifting supply leftward and driving up the price of bread
Analysis:
→ Rightward Shift Process → Increase in supply → Surplus at initial price → Price falls → Extension along the demand curve to a lower equilibrium price
→ Leftward Shift Process → Decrease in supply → Shortage at initial price → Price rises → Contraction along the demand curve to a higher equilibrium price
Evaluation:
→ Price volatility in agricultural markets is high due to unpredictable supply shifts caused by climate conditions
→ The responsiveness of demand (PED) determines how significantly quantity traded changes when supply shifts
Consequences of Price Changes on Sales & Revenue
→ Effect on Sales Volume → Price changes alter quantity demanded according to the Law of Demand (price and quantity demanded move inversely)
→ Higher Equilibrium Price → Reduces sales volume (quantity traded) when caused by a decrease in supply, but increases sales volume when caused by an increase in demand
→ Lower Equilibrium Price → Increases sales volume when caused by an increase in supply, but reduces sales volume when caused by a decrease in demand
→ Impact on Total Revenue → Total Revenue = Price × Sales Quantity; the overall financial effect depends on PED
Example:
→ A price increase resulting from higher raw material costs reduces smartphone sales volume, but total sales revenue may rise if demand is inelastic
Analysis:
→ Price Rise Consequences → Reduces consumer purchasing power → Contracts demand → Decreases unit sales unless driven by stronger consumer preferences
→ Price Fall Consequences → Increases product affordability → Extends demand → Boosts unit sales, benefiting market expansion
Evaluation:
→ Businesses must evaluate price elasticity before altering prices to predict the outcome on total sales revenue accurately
→ Long-term sales outcomes may differ from short-term outcomes as consumers find substitutes over time
Illustrating Changes in Market Conditions
1. Increase in Demand (Shift Right):
→ Diagram Movement → Curve D shifts to D1 → Equilibrium point moves from E to E1
→ Market Effect → Equilibrium price rises (P to P1) and equilibrium quantity increases (Q to Q1)
2. Decrease in Demand (Shift Left):
→ Diagram Movement → Curve D shifts to D1 → Equilibrium point moves from E to E1
→ Market Effect → Equilibrium price falls (P to P1) and equilibrium quantity decreases (Q to Q1)
3. Increase in Supply (Shift Right):
→ Diagram Movement → Curve S shifts to S1 → Equilibrium point moves from E to E1
→ Market Effect → Equilibrium price falls (P to P1) and equilibrium quantity increases (Q to Q1)
4. Decrease in Supply (Shift Left):
→ Diagram Movement → Curve S shifts to S1 → Equilibrium point moves from E to E1
→ Market Effect → Equilibrium price rises (P to P1) and equilibrium quantity decreases (Q to Q1)
Analysis:
→ Simultaneous Shifts → If demand and supply shift at the same time, the effect on either price or quantity will be uncertain without knowing the relative size of each shift
→ Diagrammatic Rules → Always label axes (Price and Quantity), initial curves (D, S), new curves (D1, S1), and equilibrium points (P, Q to P1, Q1)
Evaluation:
→ Diagrams assume ceteris paribus (all other variables remain constant), which rarely holds true in real economic markets
→ Time lags mean market adjustments to new equilibrium positions are rarely instantaneous