What Happens When the Supply Curve Shifts

For most goods and services, it is a bit easier to predict changes in supply than changes in demand. Physical factors that affect supply, like weather or the availability of inputs, are easier to get a handle on than the fickle tastes that affect demand. Still, with supply as with demand, what we can best predict are the effects of shifts of the supply curve.

As we mentioned in the opening story, improved drilling technology significantly increased the supply of natural gas from 2006 onward. Figure 3-15 shows how this shift affected the market equilibrium. The original equilibrium is at E1, the point of intersection of the original supply curve, S1, with an equilibrium price P1 and equilibrium quantity Q1. As a result of the improved technology, supply increases and S1 shifts rightward to S2. At the original price P1, a surplus of natural gas now exists and the market is no longer in equilibrium. The surplus causes a fall in price and an increase in the quantity demanded, a downward movement along the demand curve. The new equilibrium is at E2, with an equilibrium price P2 and an equilibrium quantity Q2. In the new equilibrium E2, the price is lower and the equilibrium quantity is higher than before. This can be stated as a general principle: When supply of a good or service increases, the equilibrium price of the good or service falls and the equilibrium quantity of the good or service rises.

Equilibrium and Shifts of the Supply Curve The original equilibrium in the market is at E1. Improved technology causes an increase in the supply of natural gas and shifts the supply curve rightward from S1 to S2. A new equilibrium is established at E2, with a lower equilibrium price, P2, and a higher equilibrium quantity, Q2.

PITFALLS

PITFALLS: WHICH CURVE IS IT, ANYWAY?

WHICH CURVE IS IT, ANYWAY?
When the price of some good or service changes, in general, we can say that this reflects a change in either supply or demand. But it is easy to get confused about which one. A helpful clue is the direction of change in the quantity. If the quantity sold changes in the same direction as the price—for example, if both the price and the quantity rise—this suggests that the demand curve has shifted. If the price and the quantity move in opposite directions, the likely cause is a shift of the supply curve.

What happens to the market when supply falls? A fall in supply leads to a leftward shift of the supply curve. At the original price a shortage now exists; as a result, the equilibrium price rises and the quantity demanded falls. This describes what happened to the market for natural gas after Hurricane Katrina damaged natural gas production in the Gulf of Mexico in 2006. We can formulate a general principle: When supply of a good or service decreases, the equilibrium price of the good or service rises and the equilibrium quantity of the good or service falls.

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