Hint for Solving Supply/Demand Problems

Suggested approach to problems calling for you to graph and/or solve for the new equilibrium price and quantity exchanged—given some change in demand and/or supply conditions:

Step 1. Graph and mark the initial equilibrium positions. Be sure to label your graph correctly. Label the vertical axis in terms of price of whatever you are asked to examine. For example, if you are looking at the market for banana splits, then label the vertical axis P_bs. Mark the equilibrium price and quantity exchanged (amount bought and sold) before the given change occurs.

Step 2. If the problem involves two goods that are substitutes (eg., Goods A and B are substitute goods for consumers), a good that is a normal good (eg., Good N is a normal good for consumers), or whatever—do your analysis in terms of goods that fit the given conditions FOR YOU PERSONALLY. That is, pick two goods that are substitutes for you. Or pick a good that is a normal good for you.

Step 3. Now given the change (that is the basis of the problem), ask the question:

a) Does the demand curve shift? To answer this question, ask yourself the second question, “Has one of the ‘other things’ (nonprice determinants) of demand changed?” If the answer is no, then demand curve does not shift; proceed to step 3b. But if the answer is yes, then you must determine whether the demand curve would shift rightward, or leftward. Here you have to think a bit. Would this change (the given change) cause people (such as me) to want more of the good, or less? If more, then shift the demand curve to the right. If less, then shift the demand curve to the left.

b) Does the supply curve shift? Here, ask yourself, “Has one of the ‘other things’ (nonprice determinants) of supply changed?” If not, then the supply curve does not shift. If yes, then the supply curve must shift, but which direction? Here, ask whether this change would cause sellers to want to put more of the good on the market, or less. If more, then shift the supply curve to the right. If less, shift it to the left.

Step 4. Now that you have shifted the proper curve in the right direction, mark the new equilibrium price and quantity exchanged on the graph. Problem solved!

Step 5. If the problem is one in which both the demand curve and the supply curve shift, then shift one curve (either one) a medium amount, but then shift the other first, a very small amount, then a very large amount. Doing this, you will find that how much you shift the curves does not affect one variable (either price or quantity exchanged), but the other will increase or decrease depending on how much you shifted the curve. That variable is said to be indeterminate.

Note - Instead of the phrase “quantity exchanged” you may substitute the term “sales”. At that price at which the amount that buyers are willing to take off the market (quantity demanded) is just equal to the amount that sellers are willing to place on the market (quantity supplied), we establish the quantity actually exchanged, ie., sales