When we begin shifting the Demand and/or the Supply curves, it’s easy to get confused. From not knowing which curve to shift (or which curves to shift, sometimes they both shift!), the direction of the shift (or shifts!), the magnitude of the shift, all those different curves intersecting… sighs. I get it.
Let me try to help. Here are a few tips to ensure you get the right answer, including a few graphing tips at the bottom. The truth is, a good graph will never fail you. Unless you draw it wrong, that is (duh!).
Before I get to it, a piece of advice. Avoid reading this material as if it were a novel. Rather, read actively and ensure every step makes sense to you. Practice summarizing the steps and, when you are familiar with them, try to change their order or condense them and still make sense of the problem (I think you can). Also try out abbreviations that "speak to you," I often use up arrows to signal an increase and down arrows to signal a decrease, or pluses and minuses, respectively, but maybe you have a better idea. By focusing and thinking deeply about the steps, you will (1) remember it in the future and (2) be able to do it independently when given a new scenario, like in an exam or in your life.
Movement (Along) Versus Shift: Same Difference?
If you’re still stuck on the distinction between a movement along a curve (caused by a change in the price of the good, ceteris paribus) and a shift of the curve (caused by a change in something else other than price, say a change in income if the change occurred on the Demand-side or a change in the cost of inputs if the change occurred on the Supply-side), check out my Changes in Quantity Demanded vs Changes in Demand explanation, where I guide you through an example using Eric Lawson’s stance on smoking (Eric was an actor who portrayed the Marlboro Man in a series of ads and later appeared in anti-smoking campaigns).
3-Steps to Analyze Changes in Equilibrium
In general, these problems are solved in 3 steps:
STEP 1. Identify whether the event changes Demand and/or Supply
This is where you interpret the exercise, and it may be the most difficult step. FYI, most exercises don’t just ask what happens to equilibrium price when Demand and/or Supply increase, as it’s the ability to interpret the events that matters in the real world. Furthermore, I often see students fall into the trap of thinking about what they would do if they were in the situation described in the exercise and ignore the text. Resist that temptation and stick to the information you are given. In short, don’t make stuff that is not there.
Here are four backstories… Start by identifying whether the event changes Demand, Supply, or both before looking at my analysis, and then see if you got them all right the first time around.
STORY #1. There was an increase in consumer income, and tablets are a normal good.
STORY #2. Studies show tablets emit radiation that causes cancer.
STORY #3. Improvement in technology in electric vehicles reduces production costs.
STORY #4. Labor unions fight and get higher wages for employees.
SOLUTION
Stories #1 and #2 refer to changes that occur on the consumer side, i.e. the Demand-side. Story #1 is describing a change in income and Story #2 is describing a change in preferences (as economists, we are able to predict behavior, and it’s fairly accurate to expect consumers to wish to fewer tablets when they learn tablets emit cancer-inducing radiation).
Stories #3 and #4 refer to changes that occur on the producer side, i.e. the Supply-side. Story #3 is describing an improvement in productivity, and Story #4 is describing an increase in input costs.
Keep in mind, changes can occur in both the consumer and producer sides simultaneously. For example, if Story #4 had happened in the tablet industry, you could be asked to analyze the effects of Stories #2 and #4 simultaneously.
STEP 2. Identify whether the event increases/decreases Demand and/or Supply, i.e. the direction of the shift: does it shift the Demand curve and/or the Supply curve rightward and/or leftward?
In Story #1, Demand increases (D+) because consumers are more willing/able to buy tablets, i.e. at any level of the price they want to purchase more tablets: Demand shifts right. In Story #2, Demand decreases (D-) because consumers are less willing/able to buy tablets: Demand shifts left.
In Story #3, Supply increases (S+) because producers are willing/able to sell more electric vehicles at any level of the price: Supply shifts right. In Story #4, Supply decreases (S-) because now that higher wages translate into more costly products, sellers are only willing/able to sell any given quantity at a higher price: Supply shifts left.
STEP 3.
Compare initial & new equilibria: compare old/new equilibrium price & quantity
Resist the urge to do the analysis in your head (or up in the air) and draw! A great graph will be theoretically correct, clear, and allow for quick analysis. Seriously, it takes less than four second to draw the two axes and a Supply and a Demand curves, including labeling all four lines. Try!
How to Draw Great Graphs & Get the Right Answer
Graphs will never fail you (unless you draw them wrong). The key to graphing is (1) practice, (2) exaggerate shifts, and (3) keep track of labels. You know, sometimes we draw the after-effect-curve so close to the first that it’s very difficult to see what is happening. We are also sometimes so much in a rush that we think it’s a waste of time to label curves — I assure you it is not. And, if it makes you feel better, know I probably did that too when I started learning, but now know better. Learn from my mistakes, young padawan.
Here’s another step-by-step guide:
I. SET UP (axes + Supply & Demand) [đź’– labels!]
- Draw & Label axes (P for Price and Q for Quantity)
- Draw & Label curves (S for Supply and D for Demand)
- Label initial Equilibrium (E0, where “0” denotes our baseline, and that is the initial, pre-shift moment)
- Label equilibrium price (P*0) and equilibrium quantity (Q*0) [did you know, we typically use “*” to denote equilibrium values]
II. SHIFT (all the above + 1 NEW Supply and/or 1 NEW Demand curve)
- Draw “ARROWS” (→) to describe the direction the curve is shifting
- Draw New Curves in “DASHES” (- – -) & Label New Curves (add a subscript to New Curve, e.g. S1 and/or D1, where “1” refers to the post-shift moment)
- Label NEW Equilibrium (E1, where “1” refers to new, post-shift moment)
- Label equilibrium price (P*1) and equilibrium quantity (Q*1) [did you notice the “*” again?]
III. OBSERVE WHAT HAPPENED TO PRICE & QUANTITY
- Change in Price: compare initial and post-shift price, P0 and P1, respectively, i.e. observe whether P1 is greater than, equal to, or less than P0.
- Change in Quantity: compare initial and post-shift quantity, Q0 and Q1 respectively, i.e. observe if Q1 is greater than, equal to, or less than Q0.
I hope these are useful!
Joana Girante 