Tuesday, May 20, 2008

A Decrease in Supply & an Increase in Demand

Click on the illustration to enlarge it.

A decrease in supply is illustrated by a shift of the supply curve to the left.

A decrease in supply can be caused by:
  • a decrease in the number of producers.
  • an increase in the costs of production (such as higher prices for oil, labor, or other factors of production).
  • weather (e.g., droughts, floods, or freezing temperatures decrease agricultural production)
  • loss of technology (Technological innovations typically increase supply. If technology were to be lost, there could be a decrease in supply.)
  • expectations (e.g., producers might decrease current production if they anticipate more favorable market conditions in the future.)
An increase in demand is illustrated by a shift of the demand curve to the right.

An increase in demand can be caused by:
  • an increase in the number of consumers.
  • an increase in income (for normal products) or a decrease in income (for inferior products, such as Ramen noodles).
  • an increase in the price of a substitute product.
  • a decrease in the price of a complementary product.
  • a change in tastes and preferences (e.g., if the product has become more popular or fashionable)
  • expectations (e.g., consumers might increase current demand if they anticipate less favorable market conditions, such as shortages or higher prices, in the future.)

When there is a decrease is supply and an increase in demand, the new equilibrium occurs at a higher market price. The new equilibrium quantity may be larger, smaller, or unchanged depending on the magnitudes of the shifts.