Demand Shifters and Supply Shifters

Why So Much Chaos in Stores Lately?

We’ve all seen store sections labeled “clearance,” “close out,” or “discount.” Why do stores end up selling these items for so much less than their original prices? 

One reason is that the market demand for those items has shifted. The store thought the items would sell at their original prices, but something happened that made consumers feel different about those items. Maybe the season changed and people no longer wanted a certain type of clothing. 

The same thing can happen with supply. Maybe you used to pay $9.99 for a certain product, when it goes viral on social media, its price spiked to $30. How can the price triple in just a few weeks?

In both of these cases, something shifted in the entire market. Whether the shift was in demand or supply, it happened across the board. We’ll explore both demand shifters and supply shifters to understand how events can impact our markets. But first, let’s brush up on demand and supply before the shifters hit.

Demand and Supply

The law of demand states that there is an inverse (opposite) relationship between the price of an item and the quantity of it that consumers are willing and able to buy. Simply put: The price goes up when a lot of people value the item, and the price goes down when fewer people value it. Whether the item is a pizza or a cell phone, you’ve seen the law of demand in action.

The law of supply notes a positive relationship between the price of an item and the quantity of it that producers are willing to supply when other factors are held constant. Higher prices give producers a greater incentive to produce goods and services, while lower prices can cut into profits.

There’s a direct relationship between supply and demand. So what happens when one or the other shifts substantially? To find out, let’s start with the demand side.

The Demand Curve

The first step in understanding demand is knowing the distinction between quantity demanded and market demand.

Imagine that you’re considering starting a dog-walking business in your neighborhood. You do a survey to gather data about how many dog walks you might expect to provide and the price people are willing to pay. You find that one person is willing to pay for your services if you charge $15, but more customers would be willing to hire you if you charged a lower price. 

You can create a table listing price and quantity demanded. Economists call this table a demand schedule. 

The quantities demanded at different price points can be used to make a demand curve. The data gives important information about what consumers are willing to pay for the dog-walking service. 

To plot a demand curve: 

1. Place the price of the item on the vertical, or y, axis. 

2. Put the quantity demanded on the horizontal, or x, axis. 

3. Mark the quantity demanded for each price with a dot. 

4. Connect the dots to plot the demand curve. 

The demand curve will slope downward to the right. This is because at a lower price, consumers will purchase a larger quantity. Correspondingly, when prices are higher, consumers will purchase less. 

What causes a movement along a demand curve? A change in the price of the item. Nothing else. If the price of a dog walk drops from $15 to $12, the number of interested customers increases from 1 to 2 customers. If the price increases from $3 to $6, the quantity demanded drops from 5 to 4. 

Demand Shifters

When deciding whether to buy a product or service at a specific price, consumers respond to many factors, not just the price of the item. For example:

• Tastes and preferences change (fads, demographic trends, etc.).

• The number of consumers of the product changes.

• The prices of related goods change, making the items comparatively more or less appealing.

• Income and access to credit rise or fall.

• Expectations of future prices or supply change. 

These are examples of demand shifters. Demand shifters, which change the quantity demanded at every price point, cause the demand curve to move right or left.

Let’s consider the power of pizza. Assume that pizza suddenly becomes widely popular because someone on the Internet says that eating pizza gives people superpowers. The story goes viral. People turn to eating pizza instead of almost everything else. This event does not involve an initial change in the price of pizza; it is a change in people’s preferences. Demand increases. So, demand shifts to the right because, at every price point people buy more pizza. 

Here are the demand schedule and demand curve for this example.

Now, imagine that the opposite happens. A story about pizza causing health problems goes viral. Everybody stops eating pizza. Preferences change again. Demand decreases. Here’s what happens to the demand schedule and the demand curve.

While changes in price cause movements along the demand curve, demand shifters move the entire curve. Demand shifts to the right if something positively impacts quantity demanded at every price point, and to the left if something negatively impacts quantity demanded at every price point. 

The rule is this: A change in the price of an item, and only a change in the price of the item, leads to a movement along a demand curve. When a factor changes all prices for that product, it shifts the whole curve.

Is It the Price?

An easy way to determine whether a force is affecting movement along a demand curve or shifting the entire curve is to ask this question: Is the price of the item changing, or is something else changing? 

Demand shifters include changes in any combination of the following factors: 

• Consumer income 

• Styles, tastes, and habits 

• Prices or availability of related goods and services 

• Weather or season 

• Number of buyers 

• Expectations 

• Available credit or taxes 

• Consumer confidence in the health of the macroeconomy 

Demand shifts occur when people feel differently about a product or service. Styles change. Fads go out of favor. The seasons change. The government offers tax incentives. Consumer confidence rises or dips. A national or global event alters marketplace realities and priorities.

The Supply Curve

It’s not just demand that can experience market shifts. Producers also face this possibility.

Producers respond to incentives. Producers are willing and able to offer more products for sale at higher prices than they are at lower prices. The higher price helps cover the higher marginal cost of producing more items. A lower price does the opposite. A supply curve can be used to show the positive relationship between price and quantity supplied.

A supply curve reflects quantities produced at each possible price. A change in the quantity supplied follows a price change, causing a movement along a supply curve. A change in any other factor leads to an increase or a decrease in supply, resulting in a shift of the supply curve. 

A supply schedule shows the quantity produced at different prices. You can use the information from the supply schedule to create a supply curve, which is a visual display of the data. The supply curve illustrates the relationship between price and the amount (or quantity) produced.

To plot a supply curve:

1. Place the price of the item on the vertical, or y, axis.

2. Put the quantity supplied on the horizontal, or x, axis.

3. Mark the quantity supplied for each price with a dot.

4. Connect the dots to plot the supply curve.

This supply curve depicts the supply of First Oil, a hypothetical oil producer. Remember, the company’s supply is the entire line, not a particular point on it.

Supply Shifters

Supply shifters cause the quantity supplied to change in response to changes in price. Supply shifters, which change the quantity supplied at every price point, cause the supply curve to move right or left.

If the price of oil goes up, what does First Oil do? The company will be motivated to produce more. And if the price goes down? The company will produce less. Is price the only factor to take into account? No, of course not. There are other considerations. 

If something other than a change in price happens that affects the amount supplied at each and every price point, it’s known as a supply shifter because it shifts the whole supply curve left or right.  

Adjustments to Changes in Supply 

What might cause changes in supply? Economists expect shifts in supply if:

• Production costs change.

• The total number of producers in the market changes.

• Producers have major changes in their expectations for future sales. 

When the quantity supplied drops, for whatever reason, the supply curve shifts to the left, meaning that the same amount of money, $4 in this example, buys less.

In contrast, when the quantity supplied rises, the supply curve shifts to the right, meaning more bang for the buck.

Six Key Supply Shifters 

Several key factors can cause supply to shift. They influence what producers do at every price point, meaning each one affects the whole supply curve. These factors reflect changes in:

1. The cost of production. 

2. The cost of resources. 

3. The number of producers. 

4. Expectations. 

5. The demand for related goods. 

6. Subsidies, taxes, and more. 

Let’s consider them one by one.

1. Change in the Cost of Production 

The production of any good or service costs money, and more production will cost even more money. However, if for some reason the cost of producing a good or service goes down for everyone, then the entire supply curve shifts to the right (representing an increase in supply). 

Common reasons for a decline in production costs include the following: 

• Technology advances.

• Employees find a more efficient way to work. 

• Businesses improve production strategies.

• Businesses find less expensive resources.

• Businesses purchase or design more efficient tools and equipment.

The electronics business is a good example. Smartphones, tablets, computers, and flat-screen televisions are more advanced today than they were five years ago. In general, the supply of digital gadgets and electronics equipment has increased, reflecting the lower production costs at every level of operation. Lower production costs mean that producers can offer their products for sale at lower prices. 

Of course, production costs can also increase. For example, if a natural disaster devastates a region, the cost of producing crops will rise, which will decrease the supply. 

2. Change in the Cost of Resources 

The costs of producing a good or service can change. The cost of producing ice cream, for example, will change when the price of one of the necessary production resources—like sugar—changes. When the price of sugar increases, the producers of ice cream will produce fewer units at each selling price. The entire supply curve of ice cream will shift to the left (a decrease in supply of ice cream) when the price of sugar increases. 

3. Change in the Number of Producers 

When businesses see big profits happening in a business they’re not in, some will enter that market. All of a sudden, the number of producers goes up and the supply increases. 

For example, when mountain bikes grew in popularity and profits rose, the number of businesses producing and selling them increased. The new producers took resources from elsewhere to make bikes. This shifted the industry’s supply curve to the right. 

4. Change in Expectations 

If producers expect higher or lower future prices for their products, they may change the amount supplied today. 

Producers want to sell the most product when they think prices will be highest, and they adjust their supply accordingly, which has an effect on the whole curve. 

5. Change in the Demand for Related Goods 

Goods that are often used together, such as cars and gasoline or cereal and milk, are complementary goods. Goods that can easily be switched out for each other are substitutes. Producers might adjust the amount of a product they supply if there is a change in the availability of complementary goods or substitutes. 

If something happens to the price of one of the complements, the other complement suppliers will change their production accordingly. Producers have alternatives. So, they will respond to a change in the price of one complement by changing the supply of the other. 

For example, if the price of gasoline is skyrocketing, producers who make cars might switch from supplying SUVs that use a lot of gas to supplying fuel-efficient electric cars. The production of substitutes is similarly affected. A price increase in butter may lead to an increase in the supply of margarine. 

6. Change in Subsidies, Taxes, and More 

If the government makes a change to the tax code, freeing up more of people’s paychecks for spending on what they need and want, it increases the supply of money people can spend. Businesses may also have more money to produce and supply more of their goods or services. The combined effect is to shift the entire supply curve to the right. Conversely, businesses will supply less when less money is available. 

Government influences supply through tax policies and subsidies, regulations, and direct government spending on goods and services. An increase in tax rates, an elimination of subsidies, or an increase in regulations may cause producers to pull back on production and supply less. By contrast, a decrease in tax rates, added subsidies, or less government regulation have the opposite effect. These factors will likely cause an increase in supply.

Summary

The COVID-19 crisis has taught us a lot about demand shifters and supply shifters. Many other factors can shift pricing up or down as well. These factors include consumer preferences, production capabilities, the cost of resources, and government policies.