Question

Illustrate, using appropriate diagrams, the effect of change in demand on equilibrium price.

Answer 1

The effect of a shift in the demand curve on the equilibrium price and quantity can be illustrated with the help of the given Fig.

The equilibrium price and quantity are determined at the point where the demand and supply curves intersect. Initially, the demand curve D₀D₀ intersects the supply curve SS at point E₀, where the equilibrium price is OP₀ and the equilibrium quantity is OQ₀. When demand increases, the demand curve shifts to the right from D₀D₀ to D₁D₁. At the original price OP₀, quantity demanded becomes OQ₃ while supply remains at OQ₀, resulting in excess demand. This creates upward pressure on the price. As the price rises, a new equilibrium is established at point E₁, with a higher price (OP₁) and higher quantity (OQ₁).

On the other hand, if demand decreases, the demand curve shifts leftward from D₀D₀ to D₂D₂. At the original price OP₀, supply exceeds demand, causing excess supply. This puts downward pressure on the price. A new equilibrium is reached at point E₂, with a lower price (OP₂) and lower quantity (OQ₂). Therefore, a change in demand causes a movement along the supply curve, raising or lowering both the equilibrium price and quantity depending on the direction of the demand shift.