Question

Market of a good is in equilibrium. If the demand for the good 'decreases'. Explain the chain of effects of this change.

 

 

Answer 1

If the market is in equilibrium and the demand decreases, then the demand curve will shift towards left as shown in the figure below:

Now, if market demand decreases, then the market demand curve shifts parallely leftwards to D₂D₂. Now, at the initial price OP₁, there exists excess supply equivalent to Oq₁ – Oq'₁ units of output. Due to the excess supply, the competition among the producers increases and they try to get rid of the excess stock by selling their output at comparatively lower price. The price will continue to fall until it reaches OP₂, and the new equilibrium is established at point E₂, where the new demand curve D₂D₂ intersects the initial market supply curve S₁S₁. Hence, a decrease in market demand with supply remaining constant, results in fall in the equilibrium price as well as the equilibrium quantity.
To summarise,
Decrease in demand ⇒ Excess supply at the existing price ⇒ Competition among the producers⇒ Fall in the price level ⇒ New equilibrium ⇒ Fall in both quantity demanded as well as price.