. © 1999 - 2004
Douglas A. Ruby
Revised: 02/13/2003


Market Analysis

Demand-Side Shocks

Supply-Side Shocks

Shocks to Both Sides of the Market
Tutorial: Exogenous Shocks in Output Markets

The demand equation may be written using the following general functional form:

Qd = f(Px; Income, Preferences, Py, # of consumers),

where 'Px' represents the "own" price of the good demanded. The variables listed after the semi-colon represent other exogenous variables that affect the quantity demanded for a particular good. 'Py' in this list represents the price of a related good (substitutes or complements).

Changes in own price (due to surpluses or shortages) will lead to a movement along the demand curve. In contrast changes in any of the exogenous variables will lead to an inward or outward shift in demand.

On the other side of the market, the supply equation may be written using the following general function form:

Qs = f(Px; Technology, Factor Prices, Taxes & Subsidies, # of producers),

where 'Px' represents the "own" price of the good supplied. The variables listed after the semi-colon represent other exogenous variables that affect the quantity supplied for a particular good. Factor prices in this list includes wages, rents, rental cost of capital (interest), and normal profits.

Changes in own price (due to surpluses or shortages) will lead to a movement along the supply curve. In contrast changes in any of the exogenous variables will lead to an inward or outward shift in supply. In general, any shock that leads to lower costs of production (technological improvements, lower factor prices, lower taxes, or increased subsidies) will lead to an outward shift in supply (holding the demand of that good constant).

We can experiment with different types of shocks in the marketplace using the interactive diagram below. Referring to the shocks listed above, do the following as you think necessary:

  • Press on the 'D+' button to simulate outward shifts in Demand and 'D-' for inward shifts. The 'D*' button will return Demand to its original position.
  • Press on the 'S+' button to simulate outward shifts in supply and 'S-' for inward shifts. The 'S*' button will return Supply to its original position.
  • Press the Price Adjustment button to see the adjustment to a new equilibrium.
  • Press Reset to start over.

Answers are below

Shocks...
A. Market: Oranges
An unexpected freeze destroys the Orange Crop.
B. Market: Personal Computers
The price of Internet Access is reduced.
C. Market: Autos
A decrease in the price of gasoline and an
improvement in automotive production technology.
D. Market:  Housing in Boulder
Zoning laws restrict new construction within the Boulder City limits.
E. Market: Restaurant Meals
The government mandates a 10% increase in wages and incomes.
F. Market: Airline Travel
Several major airports (SFO, LAX, JFK, and O'Hare) complete their expansion and moderization programs.






Answers...
A. -- The freeze will reduce the number of oranges available to the market at each and every price. This will lead to an inward shift in Market Supply. Press 'S-' and then Price Adjustment.
Net Result -- Pt. 'E', Price: , Quantity:

B. -- These two goods are probably complementary goods. A reduction in the price of Internet Access will lead to more PC's being demanded at each and every price. This will lead to an outward shift in Market Demand. Press 'D+' and then Price Adjustment.
Net Result -- Pt. 'B', Price: , Quantity:

C. -- With a reduction in Gasoline prices, consumers will begin to drive more and thus demand more autos as they put more wear and tear on their cars. An increase in production technology will lead to an increase in the number of autos produced at each and every price. Thus we will have both an outward shift in Market Demand and in Market Supply. Press 'D+' and 'S+' and then Price Adjustment.
Net Result -- Pt. 'K', Price: ?? (depends on the magnitude of the two shifts), Quantity: .

D. -- These Zoning laws would restrict the number houses available in the market at each and every price. This will lead to an inward shift in Market Supply. Press 'S-' and then Price Adjustment.
Net Result -- Pt. 'E', Price: , Quantity: .

E. -- Such a mandate would lead to higher costs of production but also greater demand (assuming that restaurant meals are a normal good). Thus we will have both an outward shift in Market Demand and an inward shift in Market Supply. Press 'D+' and 'S-' and then Price Adjustment.
Net Result -- Pt. 'C', Price: , Quantity: No Change (such a mandate often leads to higher prices with no change in output or real economic activity).

F. -- These changes should lead to improved efficiency in the production of passenger services. This will lead to an outward shift in Market Supply. Press 'S+' and then Price Adjustment.
Net Result -- Pt. 'J', Price: , Quantity: .

[We also might witness an increase in demand, not just due to lower air fares (a change in quantity demanded), but resulting from air travel becoming more pleasant (a change in Tastes and Preferences leading to a shift in demand)].