Case Studies

Market Balance: Shifts of Supply and Demand (B)

What is the correlation between supply and demand curve? What are the three stages of supply and demand analysis?

Posted: Oct 2009

The demand and supply are different functions that are co-related. The change of demand curve influences the supply curve and vice verse. The higher degree of change on one curve is making higher influence to the other curve. 

In order to analyze how an event affects the market, we do so in three stages:
1.) First, determine whether the event shifts demand curve, supply curve or both curves
2.) Second, determine whether the curve shifts to the right or left
3.) Third, with the help of supply and demand chart compares the original and the new balance.

Suppose that we are in the middle of the heat of summer. How this event affects the ice cream market? Let's do the three steps analysis:

Phases in the analysis:
1.The heat affect the demand curve. Because of the heat, people want to buy a larger quantity of ice cream. Offer curve does not change.
2.Since people consume more ice cream, the demand curve shifts right.
3.Increase of demand increases equilibrium price with $2,00 to $ 2.50 and the equilibrium quantity from 7 to 10 ice creams.
CONCLUSION: The heat increases the price of ice cream, but sell much more ice cream.

Let suppose that the sugar production fell short, and that there has been an increase in sugar prices. How this event affects the ice cream market?

Phases in the analysis:

1.Change of sugar prices (inputs needed for production of ice cream), affects the supply curve. It increases the production costs, and reduces the amount of ice cream produced by the company. Demand curve remains unchanged.

2.Supply curve moves to the right

3.Shift of supply curve increases the equilibrium of the price from 2:00 to $ 2.50, while  decreases equilibrium quantity from 7 to 4 cones.

If we combine both cases into one case, than the phases in the analysis are:
1.Both curves must shift.
2.Every curve moves in the same direction as in a separate analysis, ie the demand curve to the right and supply curve to the right.
3.There are two possible outcomes depending on the relative size of demand and supply shifts.
a) If the demand increases significantly and supply has only a small decline, then  the equilibrium quantity increases.
b) If the demand slightly increases and supply significantly decreases, equilibrium quantity decreases too

Related reading:

Aggregate Demand of Market 
Aggregate Supply of Products 
Market Balance: Demand and Supply Equilibrium