Simultaneous Shifts of Supply and Demand Curves

Finally, it sometimes happens that events shift both the demand and supply curves at the same time. This is not unusual; in real life, supply curves and demand curves for many goods and services shift quite often because the economic environment continually changes. Figure 3-16 illustrates two examples of simultaneous shifts. In both panels there is an increase in supply—that is, a rightward shift of the supply curve from S1 to S2—representing, for example, adoption of an improved drilling technology. Notice that the rightward shift in panel (a) is larger than the one in panel (b): we can suppose that panel (a) represents a small, incremental change in technology while panel (b) represents a big advance in technology. Both panels show a decrease in demand—that is, a leftward shift from D1 to D2. Also notice that the leftward shift in panel (a) is relatively larger than the one in panel (b): we can suppose that panel (a) reflects the effect on demand of a deep recession in the overall economy, while panel (b) reflects the effect of a mild winter.

Simultaneous Shifts of the Demand and Supply Curves In panel (a) there is a simultaneous leftward shift of the demand curve and a rightward shift of the supply curve. Here the decrease in demand is relatively larger than the increase in supply, so the equilibrium quantity falls as the equilibrium price also falls. In panel (b) there is also a simultaneous leftward shift of the demand curve and rightward shift of the supply curve. Here the increase in supply is large relative to the decrease in demand, so the equilibrium quantity rises as the equilibrium price falls.

In both cases the equilibrium price falls from P1 to P2 as the equilibrium moves from E1 to E2. But what happens to the equilibrium quantity, the quantity of natural gas bought and sold? In panel (a) the decrease in demand is large relative to the increase in supply, and the equilibrium quantity falls as a result. In panel (b) the increase in supply is large relative to the decrease in demand, and the equilibrium quantity rises as a result. That is, when demand decreases and supply increases, the actual quantity bought and sold can go either way depending on how much the demand and supply curves have shifted.

!worldview! FOR INQUIRING MINDS: Tribulations on the Runway

You probably don’t spend much time worrying about the trials and tribulations of fashion models. Most of them don’t lead glamorous lives; in fact, except for a lucky few, life as a fashion model today can be very trying and not very lucrative. And it’s all because of supply and demand.

Consider the case of Bianca Gomez, a willowy 18-year-old from Los Angeles, with green eyes, honey-colored hair, and flawless skin, whose experience was detailed in a Wall Street Journal article. Bianca began modeling while still in high school, earning about $30,000 in modeling fees during her senior year. Having attracted the interest of some top designers in New York, she moved there after graduation, hoping to land jobs in leading fashion houses and photo-shoots for leading fashion magazines.

But once in New York, Bianca entered the global market for fashion models. And it wasn’t very pretty. Due to the ease of transmitting photos electronically and the relatively low cost of international travel, top fashion centers such as New York and Milan, Italy, are deluged each year with thousands of beautiful young women from all over the world, eagerly trying to make it as models. Although Russians, other Eastern Europeans, and Brazilians are particularly numerous, some hail from places such as Kazakhstan and Mozambique.

The global market for fashion models is not at all pretty.

Returning to our (less glamorous) economic model of supply and demand, the influx of aspiring fashion models from around the world can be represented by a rightward shift of the supply curve in the market for fashion models, which would by itself tend to lower the price paid to models.

And that wasn’t the only change in the market. Unfortunately for Bianca and others like her, the tastes of many of those who hire models have changed as well. Fashion magazines have come to prefer using celebrities such as Beyoncé on their pages rather than anonymous models, believing that their readers connect better with a familiar face. This amounts to a leftward shift of the demand curve for models—again reducing the equilibrium price paid to them.

This was borne out in Bianca’s experiences. After paying her rent, her transportation, all her modeling expenses, and 20% of her earnings to her modeling agency (which markets her to prospective clients and books her jobs), Bianca found that she was barely breaking even. Sometimes she even had to dip into savings from her high school years. To save money, she ate macaroni and hot dogs; she traveled to auditions, often four or five in one day, by subway. As the Wall Street Journal reported, Bianca was seriously considering quitting modeling altogether.

In general, when supply and demand shift in opposite directions, we can’t predict what the ultimate effect will be on the quantity bought and sold. What we can say is that a curve that shifts a disproportionately greater distance than the other curve will have a disproportionately greater effect on the quantity bought and sold. That said, we can make the following prediction about the outcome when the supply and demand curves shift in opposite directions:

But suppose that the demand and supply curves shift in the same direction. This is what has happened in recent years in the United States, as the economy has made a gradual recovery from the recession of 2008, resulting in an increase in both demand and supply. Can we safely make any predictions about the changes in price and quantity? In this situation, the change in quantity bought and sold can be predicted, but the change in price is ambiguous. The two possible outcomes when the supply and demand curves shift in the same direction (which you should check for yourself) are as follows:

!worldview! ECONOMICS in Action: The Cotton Panic and Crash of 2011

The Cotton Panic and Crash of 2011

When fear of a future price increase strikes a large enough number of consumers, it can become a self-fulfilling prophecy. Much to the dismay of owners of cotton textile mills, this is exactly what happened in early 2011, when a huge surge in the price of raw cotton peaked, followed by an equally spectacular fall. In situations like these, consumers become their own worst enemy, engaging in what is called panic buying: rushing to purchase more of a good because its price has gone up, which precipitates only a further price rise and more panic buying. So how did cotton buyers find themselves in this predicament in 2011? And what finally got them out of it?

The process had, in fact, been started by real events that occurred years earlier. By 2010, demand for cotton had rebounded sharply from lows set during the global financial crisis of 2006-2007. In addition, greater demand for cotton clothing in countries with rapidly growing middle classes, like China, added to the increased demand for cotton. This had the effect of shifting the demand curve rightward.

Cotton Prices in the United States, 1999–2013 Source: USDA.

At the same time there were significant supply reductions to the worldwide market for cotton. India, the second largest exporter of cotton (an exporter is a seller of a good to foreign buyers), had imposed restrictions on the sale of its cotton abroad in order to aid its own textile mills. And Pakistan, China, and Australia, which were big growers of cotton, experienced widespread flooding that significantly reduced their cotton crops. The Indian export restrictions and the floods in cotton-producing areas had the effect of shifting the supply curve leftward.

So, as shown in Figure 3-17, while cotton had traded at between $0.35 and $0.60 per pound from 2000 to 2010, it surged to more than $2.40 per pound in early 2011—up more than 200% in one year. As high prices for cotton sparked panic buying, the demand curve shifted further rightward, further feeding the buying frenzy.

Yet by the end of 2011, cotton prices had plummeted to $0.86 per pound. What happened? A number of things, illustrating the forces of supply and demand. First, demand fell as clothing manufacturers, unwilling to pass on huge price increases to their customers, shifted to less expensive fabrics like polyester. Second, supply increased as farmers planted more acreage of cotton in hopes of garnering high prices. As the effects of supply and demand became obvious, buyers stopped panicking and cotton prices finally fell back down to earth.

Quick Review

  • Changes in the equilibrium price and quantity in a market result from shifts of the supply curve, the demand curve, or both.

  • An increase in demand increases both the equilibrium price and the equilibrium quantity. A decrease in demand decreases both the equilibrium price and the equilibrium quantity.

  • An increase in supply drives the equilibrium price down but increases the equilibrium quantity. A decrease in supply raises the equilibrium price but reduces the equilibrium quantity.

  • Often fluctuations in markets involve shifts of both the supply and demand curves. When they shift in the same direction, the change in equilibrium quantity is predictable but the change in equilibrium price is not. When they shift in opposite directions, the change in equilibrium price is predictable but the change in equilibrium quantity is not. When there are simultaneous shifts of the demand and supply curves, the curve that shifts the greater distance has a greater effect on the change in equilibrium price and quantity.

3-4

  1. Question 2.4

    In each of the following examples, determine (i) the market in question; (ii) whether a shift in demand or supply occurred, the direction of the shift, and what induced the shift; and (iii) the effect of the shift on the equilibrium price and the equilibrium quantity.

    1. As the price of gasoline fell in the United States during the 1990s, more people bought large cars.

    2. As technological innovation has lowered the cost of recycling used paper, fresh paper made from recycled stock is used more frequently.

    3. When a local cable company offers cheaper on-demand films, local movie theaters have more unfilled seats.

  2. Question 2.5

    When a new, faster computer chip is introduced, demand for computers using the older, slower chips decreases. Simultaneously, computer makers increase their production of computers containing the old chips in order to clear out their stocks of old chips.

    Draw two diagrams of the market for computers containing the old chips:

    1. one in which the equilibrium quantity falls in response to these events and

    2. one in which the equilibrium quantity rises.

    3. What happens to the equilibrium price in each diagram?

Solutions appear at back of book.