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Unit 3: Supply and Market Equilibrium

Graphically, the interaction of supply and demand curves will indicate the equilibrium Notes
point (E).
If market price is OP , the quantity demanded by consumers is OQ , while the quantity which
1
1
producers wish to supply is OQ . There is thus a surplus of Q Q at this price. It is well known that
2 1 2
a surplus leads to a downward pressure on price and so market price will fall. At the lower price
of OP , the quantity supplied is OQ , while the quantity demanded is OQ . There is, therefore,
2
2
1
a shortage at this price, represented by Q Q . This shortage tends to put an upward pressure on
1 2
price and market price is expected to rise.
There is only one price, at which the quantity supplied is equal to the quantity demanded, there
is no surplus or shortage, no rise or fall of price – OP . It is thus referred to as the equilibrium
e
position.
3.4.1 Complex Changes in Demand and Supply
Once price settles at an equilibrium level, it can be expected to remain there until something
happens to disturb the equilibrium. This can only be a change in one or more of the underlying
conditions of demand and/or supply which cause demand and/or supply to shift. For example,
let us consider the market for lettuces. How would this market be affected by a sudden spell
of late frost which destroyed many young plants? Clearly such an occurrence would shift the
supply curve to the left and this would result in a higher price with a lower equilibrium quantity.
Suppose, instead, that there were a long spell of warm weather so that people demanded more
lettuces to put in their summer salads. In this case the demand curve would shift to the right,
resulting in a rise both in equilibrium price and in quantity.
All sorts of things can happen to alter the underlying conditions of supply or demand but they can
all be reduced to four possibilities: either demand will shift or supply will shift; and the shift will
either be an increase or a reduction. Case I illustrates the decrease in supply of lettuces discussed
above while Case II corresponds with the increase in demand for lettuces. The possibilities are
summarised in Table 3.2.

Table 3.2: Altering the underlying Conditions of Demand and Supply

Case Shift Price Quantity
I Supply, left Increase Decrease
II Supply, right Decrease Increase
III Demand, left Decrease Decrease
IV Demand, right Increase Increase

Figure 3.5: A Decrease in Supply

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