Question

When we observe an increase in both price and quantity, we know that the demand curve must have shifted rightward. However, we cannot rule a shift in the supply curve as well. Prove this by drawing a supply-and-demand diagram for each of the following cases: a. Demand curve shifts rightward, supply curve shifts leftward, equilibrium price and quantity both rise. b. Demand and supply curves both shift rightward, equilibrium price and quantity both rise. c. Evaluate the following statement: "During the oil price spike from 2007 to mid- 2008 , we know the supply curve could not have shifted leftward, because quantity supplied rose." True or False? Explain.

Short answer

Under scenario a, both the equilibrium price and quantity increase when the demand curve shifts rightwards (increase in demand) and the supply curve shifts leftwards (decrease in supply). Meanwhile, in scenario b, both equilibrium price and quantity also increase when both the supply and demand curves shift rightwards, signifying an increase in both supply and demand. Finally, the statement pertaining to the oil price spike in 2007 to 2008 is false. An increase in quantity supplied can still occur despite a leftward shift (decrease) in the supply curve, if the price increase is significant enough to outweigh the decrease in supply.

Step-by-step solution

Analyze scenario a

Consider the scenario where the demand curve shifts rightwards (meaning an increase in demand) and the supply curve shifts leftwards (a decrease in supply). In this situation, we predict that both equilibrium price and quantity will increase. Draw a supply-and-demand diagram illustrating this scenario: the demand curve moves rightwards while the supply curve moves leftwards. The point of intersection, or the equilibrium point, moves upward indicating a rise in both price and quantity.

Analyze scenario b

Now, consider the scenario where both the demand and supply curves shift rightwards (an increase in both demand and supply). Again, it's predicted that both equilibrium price and quantity will increase. To illustrate this, draw a new supply-and-demand diagram showing these shifts. The demand and supply curves both move rightwards. The intersection equilibrium point will move upwards and to the right, showing an increase in price and quantity.

Evaluate statement

The last part of the exercise requires us to evaluate the statement: 'During the oil price spike from 2007 to mid-2008, we know the supply curve could not have shifted leftward, because quantity supplied rose.' This statement is actually false. A leftward shift in the supply curve represents a decrease in supply. However, the quantity supplied can still rise if the increase in price is sufficient to outweigh the decrease in supply. Therefore, it's not true that a leftward shift in the supply curve would necessarily mean the quantity supplied couldn't have risen. We would need more information to confirm the specific shifts of supply and demand curves that occurred during this period.

Key concepts

Demand Curve Shift

The demand curve in economic analysis portrays how much of a good consumers are willing to buy at different prices. When a demand curve shifts to the right, it indicates an increase in demand for a product at the same prices. This shift can be a result of various factors, such as increased consumer income, heightened preferences for the good, or changes in population demographics.

Understanding this concept is crucial because it directly influences market equilibrium. When the demand curve shifts rightward, the equilibrium price and quantity often rise, assuming supply remains constant. This is reflected graphically as the new intersection point between supply and demand curves occurs at a higher price level and a larger quantity.

For example, if there's a new scientific study that says eating blueberries can significantly improve memory, we'd expect more people to buy blueberries. If the supply of blueberries doesn't change, the increased demand would shift the demand curve to the right, leading to a higher price and more blueberries sold.

Supply Curve Shift

On the flip side, the supply curve represents the relationship between the price of a good and the amount that suppliers are willing to produce and sell. A leftward shift in the supply curve means that less of the good is available at each price. Causes of such a shift include an increase in production costs, a decrease in the number of suppliers, or a decline in technology.

When the supply curve shifts to the left, and demand stays the same, the equilibrium price usually increases while the equilibrium quantity decreases. However, if the demand increases simultaneously, as seen in the provided exercise scenario (a), then the equilibrium quantity can still rise along with the price. This nuanced understanding helps us analyze real-world events, such as crop failures leading to a decrease in the supply of a certain vegetable and subsequently causing prices to rise.

Equilibrium Price

Equilibrium price, a central concept in supply-and-demand analysis, is the price at which the quantity of a good demanded by consumers equals the quantity supplied by producers. This balance ensures that there's no surplus or shortage in the market. Price changes are driven by shifts in supply and demand. If demand outpaces supply, prices are pushed up until additional suppliers enter the market or consumers start to look for substitutions, restoring balance.

In scenario (b) from the exercise, when both curves shift rightward, the equilibrium price increases. This is because the additional demand puts upward pressure on prices, even though the supply has also increased. It's a delicate dance between opposing market forces, making the analysis of one without the other incomplete.

Equilibrium Quantity

Equilibrium quantity is the amount of goods that is bought and sold at the equilibrium price. It's directly tied to the shifts in both the demand and supply curves. When the demand curve shifts rightward, and the supply remains constant, the equilibrium quantity rises. Conversely, when the supply curve shifts leftward and the demand remains constant, the equilibrium quantity falls.

However, when both curves shift—as we've seen in scenario (b)—the equilibrium quantity can increase. This indicates that market activity is expanding with more products changing hands. Even in the context of the oil price spike mentioned in the exercise, an increase in price due to high demand and/or restricted supply can lead to a rise in the quantity supplied if the market adjusts accordingly. It's important for students to understand these interactions thoroughly to grasp the dynamics of real-life markets.