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Market for a good is in equilibrium. The demand for the good 'increase'. Explain the chain of effects of this change. |
Answer» Solution : Suppose `D_(1)D_(1)` and `S_(1)S_(1)` are the initial market demand curve and market supply curve, RESPECTIVELY. The initial EQUILIBRIUM is established at point `E_(1)`, where the market demand curve and the market supply curve intersects each other. Accordingly, the equilibrium price is `OP_(1)` and the equilibrium quantity demanded is `O_(q1)`. Now, assume that market demand increases (may be due to an increase in the consumer's income). This shifts the market demand curve parallel rightwards to `D_(2)D_(2)` from `D_(1)D_(1)`. While the market supply curve remains unchanged at `S_(1)S_(1)`. This imples that at the initial price `OP_(1)`. There exist excess demand equivalent to `(O_(q1)-O_(q3))` units. This excess demand will increase competition among the buyers and they will now be ready to pay a higher price to acquire more units of good. This will further raise the market price. The RISE in the price will continue till the market price becomes `OP_(2)`. The NEW equilibrium is established at point `E_(2)` where the new demand curve `D_(2)D2` intersects the supply curve `S_(1)S_(1)`. Observe that at the new equilibrium both market price and quantity demanded are more than the initial equilibrium. The new equilibrium quantity supplied `O_(q2)` and the new equilibrium with supply remaining constant, results in rise in the equilibrium price as well as the equilibrium quantity. To summarise, Increase in demand implies Excess demand at the existing price implies Competition among the buyers implies Rise in the price level implies New equilibrium implies Rise in both quantity demanded as well as price. |
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