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Step-by-step process for changes in equilibrium

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How to approach a question that requires you to draw a supply and demand diagram, and show the impact of a factor on price.

Sometimes this is described as a four step process or a five step process, but the steps are essentially the same.

Step 1. Draw a demand and supply diagram before the economic change took place.

Step 2. Decide whether the economic change being analyzed affects demand or supply. In other words, does the event refer to something in the list of demand factors or supply factors?

Step 3. Decide whether the effect on demand or supply causes the curve to shift to the right or to the left, and sketch the new demand or supply curve on the diagram.

Step 4. Determine whether the shift in the relevant curve results in a shortage (QD>QS) or surplus (QS>QD) of the good or service at the initial equilibrium price.

Step 5. Determine how the quantity demanded and quantity supplied respond to the pressure on price.

Step 6. Identify the new equilibrium and then compare the original equilibrium price and quantity to the new equilibrium price and quantity.

A worked example

A change in tastes. Young people prefer to get news on their smart phones. What does this do to the market for print media?

The Print News Market. A change in tastes from print news sources to digital sources results in a leftward shift in demand for the former. The result is a decrease in both equilibrium price and quantity. From John Lynman, Principles of Microeconomics.

Step 1.
Draw the market before the change in tastes. In this example, S0, D0, P0 and Q0 illustrate the initial equilibrium.

Step 2.
Did the change affect supply or demand? In this example, the non-price factor is a change in tastes. This change in tastes affects the demand curve.

Step 3.
Does the curve move left or right? In this example, the change in taste (a preference for getting news from smartphones) resulted in a reduction in demand for print media. There will be lower demand for print media at each and every price level. The demand curve will shift left. Draw in the new demand curve (D1).

Step 4.
Decide whether the market is in surplus or shortage. Compare the quantity demanded and the quantity supplied at P0. The quantity demanded is substantially lower than the quantity supplied (P0-S0). The market is in surplus.

Step 5.
Determine how the quantity demanded and quantity supplied respond to the pressure on price. Because the market is in surplus, firms will cut prices in order to clear the market place. There is downward pressure on the price of print media. This now results in an expansion in quantity demanded (movement along the demand curve from P0 to P1) and a contraction in quantity supplied (movement along the supply curve from Q0 to Q1).

Step 6.
Compare the new equilibrium price and quantity to the original equilibrium price. The new equilibrium (E1) occurs at a lower quantity and a lower price than the original equilibrium (E0).

Articles

This chapter from the Principles of Microeconomics by John Lynman is very good, I recommend reading and following the examples. 3.3 Changes in Equilibrium Price and Quantity: The Four-Step Process

The teaching and learning resources section of the VCAA website includes some worked examples. There is a really good worked example for analysing how non-price factors will impact equilibrium price. It is in the section of this page for Unit 3, Area of Study 1.