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Ten Principles of Economics - Part 9

Ten Principles of Economics - Part 9. Economics is the study of how society manages its scarce resources. In most societies, resources are allocated not by a single central planner but through the combined actions of millions of households and firms. Economists therefore study how people make decisions: how much they work, what they buy, how much they save, and how they invest their savings. Economists also study how people interact with one another. | CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 85 Figure 4-11 How a Decrease in Supply Affects the Equilibrium. An event that reduces quantity supplied at any given price shifts the supply curve to the left. The equilibrium price rises and the equilibrium quantity falls. Here an earthquake causes sellers to supply less ice cream. The supply curve shifts from S1 to S2 which causes the equilibrium price to rise from 2.00 to 2.50 and the equilibrium quantity to fall from 7 to 4 cones. 3. As Figure 4-11 shows the shift in the supply curve raises the equilibrium price from 2.00 to 2.50 and lowers the equilibrium quantity from 7 to 4 cones. As a result of the earthquake the price of ice cream rises and the quantity of ice cream sold falls. Example A Change in Both Supply and Demand Now suppose that the hot weather and the earthquake occur at the same time. To analyze this combination of events we again follow our three steps. 1. We determine that both curves must shift. The hot weather affects the demand curve because it alters the amount of ice cream that households want to buy at any given price. At the same time the earthquake alters the supply curve because it changes the amount of ice cream that firms want to sell at any given price. 2. The curves shift in the same directions as they did in our previous analysis The demand curve shifts to the right and the supply curve shifts to the left. Figure 4-12 illustrates these shifts. 3. As Figure 4-12 shows there are two possible outcomes that might result depending on the relative size of the demand and supply shifts. In both cases the equilibrium price rises. In panel a where demand increases substantially while supply falls just a little the equilibrium quantity also rises. By contrast in panel b where supply falls substantially while demand rises just a little the equilibrium quantity falls. Thus these events certainly raise the price of ice cream but their impact on the amount of ice cream sold is ambiguous. 86 PART