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Using Equilibrium to Describe Markets
®
AP ECoN TIP
The term equilibrium is used
in a variety of situations
to indicate balance or no
tendency for change. In
the supply and demand
model, when a market is
in equilibrium, Q = Q
s
d
and there is no shortage
or surplus, so there is no
tendency for the price to
change.
50 Macro • Unit 1 Basic Economic Concepts
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02_APKrugman4e_40932_MacroU01_002_062.indd
We have now seen that a market tends to have a single price, the equilibrium price. If the
market price is above the equilibrium level, the ensuing surplus leads buyers and sellers
to take actions that lower the price. And if the market price is below the equilibrium
level, the ensuing shortage leads buyers and sellers to take actions that raise the price.
So the market price always moves toward the equilibrium price, the price at which there
is neither a surplus nor a shortage.
Changes in Supply and Demand
The devastation of forests by the pine beetle in recent years came as a surprise, but the
subsequent increase in the price of lumber was no surprise at all. Suddenly, there was a
decrease in supply: the quantity of lumber available at any given price fell. Predictably,
a decrease in supply raises the equilibrium price.
A beetle infestation is an example of an event that can shift the supply curve for a
good without having much effect on the demand curve. There are many such events.
There are also events that can shift the demand curve without shifting the supply curve.
For example, a medical report that chocolate is good for you increases the demand for
chocolate but does not affect the supply. Events generally shift either the supply curve or
the demand curve, but not both; it is therefore useful to ask what happens in each case.
What Happens When the Demand Curve Shifts
Wood composites made from plastic and wood fibers are a substitute for lumber. If the
price of composites rises, the demand for lumber will increase as more consumers use
lumber rather than composites. If the price of composites falls, the demand for lumber
will decrease as more consumers are drawn away from lumber by the lower price of com-
posites. But how does the price of composites affect the market equilibrium for lumber?
Figure 1.6-4 shows the effect of changes in the price of wood composites on the
market for lumber. The rise in the price of composites increases the demand for lum-
ber, and a decrease in the price of composites decreases the demand for lumber. Point
E shows the equilibrium corresponding to the original demand curve, with P the
1
1
equilibrium price and Q the equilibrium quantity bought and sold.
1
An increase in demand is indicated by a rightward shift of the demand curve from
D to D , as shown in panel (a). At the original market price P , this market is no longer
1
1
2
in equilibrium: a shortage occurs because the quantity demanded exceeds the quantity
supplied. So the price of lumber rises and generates an increase in the quantity sup-
plied, an upward movement along the supply curve. A new equilibrium is established at
point E , with a higher equilibrium price, P , and higher equilibrium quantity, Q .
2
2
2
This sequence of events resulting from a change in demand reflect a general prin-
ciple: 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 of a fall in the price of wood composites?
A decrease in demand is indicated by a leftward shift of the demand curve from D to
1
D , as shown in panel (b) of Figure 1.6-4. At the original market price P , this market
2 1
is no longer in equilibrium: a surplus occurs because the quantity supplied exceeds
the quantity demanded. So the price of lumber falls and generates a decrease in the
quantity supplied, a downward movement along the supply curve. A new equilibrium
2
is established at point E , with a lower equilibrium price, P , and lower equilibrium
2
quantity, Q .
2
A fall in the price of composites reduces the demand for lumber, 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 sup-
plied, 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 equilib-
rium price and the equilibrium quantity of the good or service both fall.
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50 05/07/22 10:51 AM