Introduction

After you have worked through this section of the learning unit, you should be able to:

  • use a market diagram to illustrate and explain the likely impact of a decrease in demand and an increase in supply on the equilibrium price and quantity

We know from our previous analysis that a decrease in demand and an increase in supply will both decrease the price. A simultaneous decrease in demand and an increase in supply will therefore reduce the price, as demonstrated in the following diagram. As D decreases to D1 and S increases to S1, the equilibrium quantity price decreases from Pe to P1.

A decrease in demand and an increase in supply

However, what we cannot predict is what happens to the quantity. In the above diagram, the quantity remains unchanged since the relative shift of the demand and supply curve is the same. They both shifted by the same magnitude and the quantity therefore remains unchanged.

In the following two diagrams the quantity either increases or decreases, depending on the relative shifts of the demand and supply curves:

A decrease in demand and an increase in supply decrease the price and increase the quantity

A decrease in demand and an increase in supply decrease the price and decrease the quantity

In figure on the left, the quantity increases from Qe to Q1. This is because the relative shift of the supply curve was greater than that of the demand curve. The impact of an increase in the supply, which increases the quantity, is greater than the impact of a decrease in demand, which decreases the quantity. The net effect is an increase in the quantity.

However, in figure on the right, the quantity decreases from Qe to Q1. This is because the relative shift of the demand curve is now greater than that of the supply curve. The impact of a decrease in the demand, which decreases the quantity, is greater than the impact of an increase in supply, which increases the quantity. The net effect is a decrease in the quantity.

Watch the following video clip on a decrease in demand and an increase in supply:

Activity

Do the folowing activity:

During 2015, the demand for oil declined, while the supply of oil increased. This resulted in a decrease in the price of oil. Under which one of the following conditions would the equilibrium quantity have declined as well?



Think again.

If the decrease in demand for oil had been smaller than the increase in the supply of oil the then the equilibrium quantity would have increased.

Correct.

If the decrease in demand for oil is greater than the increase in the supply of oil the equilibrium quantity increase.