Question

In the space below, use a supply and demand diagrams to illustrate the situation where demand increases and supply also increases (at the same time). Indicate what the model predicts about the change in equilibrium price and quantity. Carefully label your diagram and explain it. (HINT: three graphs) Explain all answers fully and give concluding sentences.

Answer 1

When the demand and supply of a commodity increase at the same time due to some reason, there are three different combinations of a change in price and quantity that can be evaluated based on the percentage of change in demand and supply.

First scenario,

A constant or equal increase in both demand and supply.

In the above diagram, we can see that both supply and demand increased and the demand curve DD shifted to form DD1 and supply curve SS shifted to form SS1, the new demand, and supply curve respectively. Both increased in the equal percentage as the other, i.e., the increase in supply is equal to the increase in demand. So when this happens, the quantity demanded increases. Whereas the price remains the same. In the above diagram, we can see that the initial price is P and the quantity is Q, and the initial equilibrium point is E, where DD cuts SS. The new equilibrium point is E1 where DD1 cuts SS1, providing Q1 as the increased quantity, but the price remains the same at P. Only the quantity increases. So when the change in demand increases or decreases in the same percentage as supply, increase or decrease, the quantity increases whereas the price remains the same.

Second scenario,

Supply increases more than demand.

Here, the change in supply is much more than the change in demand. Supply increased to a greater percentage than demand and shift to a new supply curve SS1 from the initial supply curve SS. The demand curve DD shifts to DD1 but the increase in demand is very less compared to the increase in supply. The initial price was P, the initial quantity being Q and the equilibrium point is E. After the increase in both demand and supply, a new equilibrium position is formed at E1, where the new demand curve DD1 cuts the new supply curve SS1 and we get price P1, and quantity Q1. But here, the new price is less than the previous old price, whereas the quantity demanded increased from Q to Q1 and price P falls to P1. Now we can see that the increase is supply is more, which means the producers are offering more products whereas the increase in demand is less, so the increased demand is as per the increased supply, instead, the magnitude of increase in demand is very less. Since the increase in supply is more, and the increase in demand is less, the price of the commodity falls. But the quantity demanded increases due to a reduced price. So we can see that when supply increases more than demand then the quantity demanded increases whereas price falls.

Third scenario,

Demand increases more than supply.

Now in this situation, the increase in demand is at a higher magnitude than supply. The initial demand curve DD increased and shifted to DD1 with initial supply curve SS which increased at a lower magnitude than demand and formed the new supply curve SS1. The initial equilibrium E, where DD and SS meet, shifts to E1, where SS1 and DD1 meet, providing an increased quantity demanded, as quantity increases from Q to Q1. But the price also increases from initial price P to a new price of P1. Now this happens because the quantity demanded is more than the supply. The increased demand is more than the increased supply which increases the quantity demanded as well as the price since supply is less than demand. We saw earlier when supply was more than demand price decreased although quantity increased, so in this scenario the price increases, as well as the quantity, demanded.

To conclude, when the increase in the magnitude of demand and supply are equal, only quantity demanded increases, whereas the price remains the same. When the increase in supply is more than demand, the quantity increases but the price falls. And finally, when the increase in demand is more than the increase in supply, then the price increases along with the quantity demanded. So in all three cases, the quantity increases with an increase in demand and supply. But when both increases at the same rate, price does not change, when demand increases more, price increases, and when supply increases more, price falls.