What Happens When the Demand Curve Shifts

Heating oil and natural gas are substitutes: if the price of heating oil rises, the demand for natural gas will increase, and if the price of heating oil falls, the demand for natural gas will decrease. But how does the price of heating oil affect the market equilibrium for natural gas?

Figure 3-14 shows the effect of a rise in the price of heating oil on the market for natural gas. The rise in the price of heating oil increases the demand for natural gas. Point E1 shows the equilibrium corresponding to the original demand curve, with P1 the equilibrium price and Q1 the equilibrium quantity bought and sold.

Equilibrium and Shifts of the Demand Curve The original equilibrium in the market for natural gas is at E1, at the intersection of the supply curve and the original demand curve, D1. A rise in the price of heating oil, a substitute, shifts the demand curve rightward to D2. A shortage exists at the original price, P1, causing both the price and quantity supplied to rise, a movement along the supply curve. A new equilibrium is reached at E2, with a higher equilibrium price, P2, and a higher equilibrium quantity, Q2. When demand for a good or service increases, the equilibrium price and the equilibrium quantity of the good or service both rise.

An increase in demand is indicated by a rightward shift of the demand curve from D1 to D2. At the original market price P1, this market is no longer in equilibrium: a shortage occurs because the quantity demanded exceeds the quantity supplied. So the price of natural gas rises and generates an increase in the quantity supplied, an upward movement along the supply curve. A new equilibrium is established at point E2, with a higher equilibrium price, P2, and higher equilibrium quantity, Q2. This sequence of events reflects a general principle: When demand for a good or service increases, the equilibrium price and the equilibrium quantity of the good or service both rise.

What would happen in the reverse case, a fall in the price of heating oil? A fall in the price of heating oil reduces the demand for natural gas, shifting the demand curve to the left. At the original price, a surplus occurs as quantity supplied exceeds quantity demanded. The price falls and leads to a decrease in the quantity supplied, resulting in a lower equilibrium price and a lower equilibrium quantity. This illustrates another general principle: When demand for a good or service decreases, the equilibrium price and the equilibrium quantity of the good or service both fall.

To summarize how a market responds to a change in demand: An increase in demand leads to a rise in both the equilibrium price and the equilibrium quantity. A decrease in demand leads to a fall in both the equilibrium price and the equilibrium quantity.