Question

Explain through a diagram the effect of a rightward shift of both the demand and supply curves on equilibrium price and quantity.

Answer 1

(a) When demand and supply increase in the same proportion:

E₁ is the initial equilibrium with equilibrium price P₁ and equilibrium output q₁. 

Now, let us suppose that the demand increases to D₂D₂ and the supply increase to S₂S₂ by the same proportion. The new demand and new supply curve intersect at E₂, which is the new equilibrium, with a new equilibrium output q₂, but the same equilibrium price P₁. Thus, an increase in the demand and the supply by the same proportion leaves the equilibrium price unchanged. 

(b) When demand increases more than the increase in supply: The original demand and supply curves intersect each other at E₁ with initial equilibrium price P₁ and initial equilibrium output q₁. 

Now, let us suppose that the demand increases and thereby the demand curve shifts to D₂D₂; the supply curve also shifts rightwards to S₂S₂. However, the increase in supply is less than the increase in demand. The new supply curve and the new demand curve intersect each other at point E₂ with higher equilibrium price P₂ and higher equilibrium output q₂.

(c) When the increase in demand is less than the increase in supply: Let the initial equilibrium be at E₁ with the equilibrium price P₁ and equilibrium output q₁. Now, let us suppose that the demand increases to D₂D₂ and the supply increases to S₁S₁; where the increase in supply is more than that of demand. The new demand curve D₂D₂ and the new supply curve S₂S₂ intersect at E₂. Thus, the greater increase in supply curve as compared to the demand curve will lead the equilibrium price to fall and equilibrium output to rise.