Introduction to the classic supply and demand model
- Understand some of the factors that cause supply and demand curves to shift
- Visualize the shift of a demand curve and the resulting change in the predicted equilibrium
2. Shifting Supply and Demand in the Classic Model
One of the key uses of the supply and demand model is to explore what happens when the supply curve or the demand curve (or both) shift in some direction. Let's explore this with a specific example.
Click on the "Generate Data" button below to generate a random demand curve and a random supply curve with prices ranging from around $1 to $30. As in the previous section, the horizontal black line shows the equilibrium price, and the vertical black line shows the equilibrium quantity.
Click "Generate Data" to view results
There are a number of factors that can cause the demand and/or supply curves to shift. For demand, this includes things like changes in buyers' preferences, levels of income, and the prices of other goods. For supply, this includes things like costs of inputs, technological innovation, and the number of sellers.
Recall the equations for the demand and supply curves that we reviewed in the previous section:
QD = a + bP
QS = c + dP
The intercept and slope of the demand curve are captured by a and b, respectively. If we wanted to "shift" the demand curve either in or out (without changing its slope), we could either decrease or increase the value of a.
Similarly, the intercept and slope of the supply curve are captured by c and d, respectively. If we wanted to "shift" the supply curve either in or out (without changing its slope), we could either decrease or increase the value of c.
To take a concrete example, let's assume that all buyers in this market decide that they want less of this good, perhaps because a competing good has gotten cheaper (more on this later). This will shift the demand curve "in" (to the left). Click on the "Shift Demand Curve" button below to generate this scenario using the market we created above. Once the diagram appears, click on the "Run" button to watch the transition in action.
Click "Shift Demand Curve" to view results
The diagram illustrates that two changes occur: the equilibrium price is lower, and the equilibrium quantity is also lower. This provides a theoretical background for the narrative that when people want less of something than they did before, the price tends to go down (barring any other changes).
Note that the animation in the diagram, and particularly the movement of the equilibrium lines, is purely for illustrative purposes. The classic supply and demand model makes no claims about how the equilibrium price and quantity adjust; rather, it says that in the initial configuration, there is a certain clearing price and quantity, and in the second situation, there is a different clearing price and quantity. In comparing these situations, we are essentially looking at the differences between two static pictures.
In the previous section, we showed that the equilibrium price and quantity in a market can be determined by finding the unique price (and in turn, the unique quantity) that solves this equation:
a1 + bP1 = c1 + dP1
where a1 and c1 represent the initial demand and supply intercepts, respectively, and where P1 is the equilibrium price implied by the orientation of the curves and the market-clearing assumption.
A shift in the demand curve (with no slope change) can be captured by changing the value a1 to some other value a2. Similarly, a shift in the supply curve (with no slope change) can be captured by changing the value c1 to some other value c2. With these changes, the new equation to be solved is:
a2 + bP2 = c2 + dP2
where P2 is the new equilibrium price implied by the shifted curves and the market-clearing assumption.
Depending on the specifics, it may be that P1 > P2 , P2 > P1 , or even that P1 = P2 if the shifts in the curves are offsetting. However, because there is no time element in the model—and because buyers and sellers are both assumed to be price-takers—there is no formal concept of how or why there is a change from P1 to P2. We can describe how we think adjustments take place, or what "intermediate" prices the market may see during the adjustment period, but these ideas are based on intuition or on real-world observations and not on the model itself.
In a traditional economics course, this setup is applied to many different situations, such as various markets (for example, the market for labor or the market for laptops), various scenarios (for example, shifts in demand and shifts in supply), and various external interventions (for example, taxes levied by a government). There are many online resources that discuss these topics, and we encourage the learner to explore those.