Question

Draw a supply and a demand curve and label the market equilibrium on the axes with P1 and Q1.

In the same graph, show the effects of an increase in supply and an increase in demand on price and quantity. Label the new equilibrium values on the axes with P2 and Q2.

Add one more curve – either for supply or demand demand – to your graph and show that the effect of a simultaneous increase in supply and demand on the equilibrium price can be ambiguous.

Answer 1

If both demand and supply increase, there will be an increase in the equilibrium output, but the effect on price cannot be determined.

P1 and Q1 are initial equilibrium price and quantity. When supply increases, the supply curve shifts to the right. When demand increases, the demand curve shifts to the right.

When the increase in demand is D1 and increase in supply is S1, the new price is P2 and quantity Q2. The demand curve shifts in a larger magnitude than the supply curve. The price is higher.

The third demand curve is D2, which is the blue line. The demand curve shifts by a smaller magnitude than the supply curve, the increase in price is also less, which P3. (P3 < P2).