Economics: Markets and Prices (G00A5a)
Module 1.4
Market changes
We are now ready to discuss how changes in certain factors aect the market equilibrium. A
comparison between two equilibria is called a comparative statics exercise. We have already
seen that certain changes, such as a rise in income or a change in the price of a related good, aect
the demand function. Conversely, other changes, such as a technological breakthrough or a change
in the price of production inputs, aect the supply function. Here, we will see how a shift in either
of the two curves leads to a new market equilibrium.
Changes in demand
Consider a generalized income increase in the population. For the same price p, consumers are ready
to buy more units of a normal good x. If the initial equilibrium is characterized by the allocation
(p∗ , x∗ ), an upward shift in the (inverse) demand function leads to a temporary situation of excess
demand, i.e., the demand x′ exceeds the current supply x∗ . Firms will adjust their production to
meet consumers' demand. As rms expand production, prices increase from p∗ to p∗∗ . The new
equilibrium is characterized by an increased output x∗∗ > x∗ .
Figure 1: Comparative statics: income increases
p
pS (x)
p∗∗
p∗ pD (x)
pD (x)
x∗ x∗∗ x′ x
Changes in supply
Consider a sudden decrease in the price of raw materials. For the same price p, rms are ready to
produce more units of a good x. If the initial equilibrium is characterized by the allocation (p∗ , x∗ ),
1
a downward shift in the (inverse) supply function leads to a temporary situation of excess supply,
since rms are ready to produce x′ at the current price p∗ , but consumers would only buy x∗ < x′ .
Hence, prices fall from p∗ to p∗∗ , partly discouraging rms from expanding production. The new
equilibrium is characterized by both a higher quantity x∗∗ > x∗ and a lower price p∗∗ < p∗ .
Figure 2: Comparative statics: falling input prices
p
pS (x)
pS (x)
p∗
p∗∗
pD (x)
x∗x∗∗ x′ x
