Impact of Demand or Supply Shocks

Demand and Supply: Shifts vs Movements

The central question: how various factors affect the quantity of pizza buyers want to buy in a town, and how to distinguish movements along curves from shifts of curves.
Real-world context used in the lecture:
- Pizza market in Indiana, Pennsylvania as a static example to discuss demand factors and price effects.
- Substitutes can influence demand for pizza: prices of hamburgers, Kentucky Fried Chicken, Taco Bell can affect how much pizza is demanded if they become cheaper substitutes.
- The classic phrase: ceteris paribus (all other things held constant) is the assumption when analyzing the effect of price changes on quantity demanded.
Key definitions:
- Demand curve (D): shows the relationship between the price of pizza and the quantity demanded, holding all other factors constant.
- Law of demand: when the price of pizza rises, quantity demanded falls; when the price falls, quantity demanded rises (ceteris paribus).
- Shift vs movement along: a movement along the demand curve occurs when the price changes while other factors stay the same; a shift occurs when a non-price factor causes the entire demand curve to move.
Distinguishing shifts vs movements on the demand side:
- Rise in demand = a rightward shift of the demand curve (D1 to the right of D0).
- Fall in demand = a leftward shift of the demand curve (D0 to the left of D1).
Distinguishing shifts vs movements on the supply side:
- Rise in supply = a rightward shift of the supply curve (S1 to the right of S0); for a given price, more pizzas are supplied.
- Fall in supply = a leftward shift of the supply curve (S0 to the left of S1); for a given price, fewer pizzas are supplied.
Movement along a curve vs shifts summarized:
- Rise in quantity demanded: movement along the existing demand curve to a higher quantity as price falls (P falls, Qd rises along the same curve).
- Fall in quantity demanded: movement along the existing demand curve to a lower quantity as price rises (P rises, Qd falls along the same curve).
- Rise in demand: shift of the entire demand curve to the right; price and quantity at equilibrium both rise (in the ceteris paribus framework).
- Fall in demand: shift of the entire demand curve to the left; price and quantity at equilibrium both fall.
The same distinctions apply to the supply side:
- Rise in quantity supplied: movement along the supply curve as price increases (P increases, Qs increases along the same curve).
- Fall in quantity supplied: movement along the supply curve as price decreases (P decreases, Qs decreases along the same curve).
- Rise in supply: shift of the entire supply curve to the right; equilibrium price falls and equilibrium quantity rises.
- Fall in supply: shift of the entire supply curve to the left; equilibrium price rises and equilibrium quantity falls.
Visual takeaway: when the entire curve shifts, you’re observing a change in demand or supply due to non-price factors; when you move from one point to another along the same curve, you’re observing a change due to price movement only.

Equilibrium, shocks, and outcomes

Market equilibrium is where demand and supply intersect; there is an equilibrium price and an equilibrium quantity.
Example setup (pizza-inspired):
- Initial market with supply curve S0 and demand curve D0 intersecting at price $P0$ and quantity $Q0$ .
- If demand increases (rise in demand, rightward shift of D), the new equilibrium is at the intersection of D1 (new demand) with S0. Result: $P1 > P0$ and $Q1 > Q0$ .
- If demand decreases (fall in demand, leftward shift of D), the new equilibrium is at the intersection of D0 with S0; price and quantity fall: $P2 < P0$ and $Q2 < Q0$ .
- If supply increases (rise in supply, rightward shift of S), the new equilibrium is at the intersection of D0 with S1; price falls and quantity rises: $P3 < P0$ and $Q3 > Q0$ .
- If supply decreases (fall in supply, leftward shift of S), the new equilibrium is at the intersection of D0 with S1? (note: leftward shift of S means the new supply is S2 which lies to the left of S0); price rises and quantity falls: $P4 > P0$ and $Q4 < Q0$ .
Concrete numerical illustrations used in the lecture:
- Oil market baseline:
- Initial equilibrium: price $P = 55$ , quantity $Q = 22,000,000$ barrels/day.
- Rise in demand: new equilibrium has price and quantity both higher than the baseline (P > 55, Q > 22,000,000).
- Fall in demand: new equilibrium has price and quantity both lower than the baseline (P < 55, Q < 22,000,000).
- Rise in supply: new equilibrium is at price below 55 and quantity above 22,000,000 (P < 55, Q > 22,000,000).
- Fall in supply: new equilibrium has price above 55 and quantity below 22,000,000 (P > 55, Q < 22,000,000).
- Takeaway: these are the four basic shock types you must be able to identify and analyze quickly.
Practical note for analysis:
- If both demand and supply shocks occur simultaneously, you can still analyze each separately to understand potential directional changes, but the combined effect depends on the relative magnitudes of the two shocks.
Worked problem setup from the slides (an exam-style example):
- Given an initial market equilibrium at $P = 10$ and $Q = 4{,}000$ units.
- Current market price is $P = 8$ (below the equilibrium price).
- Analysis steps to determine what could be correct:
- Graph the initial equilibrium; then place price at $P = 8$ and examine implied quantities:
  - At $P = 8$ , quantity demanded is greater than 4,000 (because the lower price makes buyers want more than at the equilibrium price).
  - At $P = 8$ , quantity supplied is less than 4,000 (because producers supply less at the lower price than at the equilibrium price).
- Therefore, there is a shortage at $P = 8$ (quantity demanded > quantity supplied).
- Possible incorrect statements: any claim that at $P = 8$ the quantity demanded equals 4,000, or that quantity supplied equals 4,100, or that there is a surplus, etc.
- Possible correct statements (examples):
  - Quantity demanded could be something like $Q_d = 4{,}150$ (greater than 4,000).
  - Quantity supplied could be something like $Q_s = 3{,}825$ (less than 4,000).
  - There is a shortage at the current outcome (demand exceeds supply by some amount).
- The key skill: take the initial equilibrium and then assess what a given price implies for demand and supply, determine whether there is a shortage or surplus, and then infer which statements about prices and quantities could be correct.
Final takeaway for exam preparation:
- You should be able to:
- Distinguish between movements along a curve and shifts of a curve for both demand and supply.
- Identify and label rises/falls in demand and rises/falls in supply as rightward or leftward shifts respectively.
- Understand how these shifts affect equilibrium price and quantity.
- Apply the four shock scenarios to predict the direction of price and quantity changes.
- Solve quick equilibrium problems where you are given a current price/quantity and a baseline equilibrium, then determine shortages or surpluses and evaluate possible statements about Qd, Qs, and market conditions.

Quick reference formulas and concepts (summary)

Demand shift: shift to the right = rise in demand; shift to the left = fall in demand.
Supply shift: shift to the right = rise in supply; shift to the left = fall in supply.
Movement along the curves:
- Along demand: price change with quantity demanded changing accordingly.
- Along supply: price change with quantity supplied changing accordingly.
Equilibrium condition: the market clears when Qd = Qs at price P and quantity Q.
Example notations:
- Initial equilibrium: $P0, Q0$ (e.g., $P0 = 13, Q0 = 600$ in a pizza example).
- After demand shift: new equilibrium at intersection of D1 with S0, with $P1 > P0, Q1 > Q0$ .
- After supply shift: new equilibrium at intersection of D0 with S1, with $P3 < P0, Q3 > Q0$ (rise in supply).
Conceptual reminder:
- Prices are just one lever; non-price factors can move market fundamentals through shifts in demand or supply, leading to new equilibria.

Key terms to remember for the exam

Ceteris paribus (Latin): all else equal; used to isolate the effect of price changes on quantity demanded.
Demand curve (D): relationship between price and quantity demanded, holding other factors constant.
Supply curve (S): relationship between price and quantity supplied, holding other factors constant.
Rise in demand / Rise in supply / Fall in demand / Fall in supply: shifts of the respective curves to the right or left.
Rise in quantity demanded / Fall in quantity demanded: movements along the demand curve, caused by price changes.
Rise in quantity supplied / Fall in quantity supplied: movements along the supply curve, caused by price changes.
Shortage: when quantity demanded exceeds quantity supplied at a given price.
Surplus: when quantity supplied exceeds quantity demanded at a given price.

Quick practice prompts (based on the lecture content)

If the demand curve for coconuts shifts right while the price stays the same, what happens to the equilibrium price and quantity?
If the price of a substitute good falls, what is the likely effect on the demand for pizza (holding other factors constant)?
In the oil example, what are the qualitative effects on P and Q for each of the four shocks?
Given an initial equilibrium at $P = 10, Q = 4{,}000$ and a current price of $P = 8$ , describe the state of the market (shortage or surplus) and identify at least one possible value for $Qd$ and one for $Qs$ consistent with this price.