2.6 Price changes

Causes and consequences of price changes

Changes in non-price factors that affect demand or supply will cause a change in the equilibrium price and quantity traded. For example, in Figure 10.1, a sales tax imposed on tobacco products will shift the supply curve of cigarettes to the left. This raises the market equilibrium price from P1 to P2 and reduces the equilibrium quantity traded from Q1 to Q2.

Figure 10.1 could represent any factor that shifts the supply curve to the left (see Chapter 8). For example, adverse weather conditions could reduce the level of agricultural output and subsequently force up the equilibrium price. By contrast, any factor that shifts supply to the right can be represented by Figure 10.2. For example, a subsidy for farmers or favourable weather conditions will shift the supply of agricultural output to the right. This reduces the equilibrium price of agricultural output from P1 to P2 but increases the quantity traded from Q1 to Q2.

Price changes can also occur due to shifts in demand (see Chapter 7). For example, any factor that shifts the demand curve to the right — such as higher levels of disposable income or effective persuasive advertising — will lead to higher prices as well as higher levels of quantity demanded. In Figure 10.3, higher household incomes lead to an increase in the demand for new cars, thus shifting the demand curve from D1 to D2. This results in a higher equilibrium price of P2 and a higher equilibrium quantity of Q2.

By contrast, a fall in demand — perhaps due to negative publicity, lower prices of substitute products or lower household income due to a recession (see Chapter 29) — will cause the demand curve to shift to the left. This will result in a fall in price and a fall in the quantity traded. In Figure 10.4, mass unemployment in the economy leads to a fall in the demand for helium balloons. This causes the equilibrium quantity traded to fall to Q2 and the equilibrium price to fall to P2.