Survey of Economics (ECO 101) Dr.

Mary Habib

Chapter 3

How Markets Work:

The Supply and Demand Model
Part One– Some Terminology and Basic Concepts

I. Introduction

As we have seen, one of the key words in economics is

"allocation." For a firm or a nation, to allocate (scarce)
productive resources is to determine what to produce
using which resources (how much labor, capital, or land
should go into the production of each good or service).

For a consumer or household, to allocate (scarce) financial

resources is to determine what to buy with how much
money (how much to spend on housing versus education
versus food, and so on).
In market economies (like the ones most people
in the world currently live in), these resources
are allocated through the market mechanism.

The allocation of resources through markets is a

complex process.

Economists approach this complex process by

conceiving a model based on some of the key
aspects of the market system.
The most powerful, and most widely used model
is the “Supply and Demand Model”.

In fact, the terms “supply” and “demand” are

probably the most frequently used pair of terms
one comes across when reading or hearing
news about the economy and economic events.
II. The Circular Flow of Economic Activity

First a couple of fundamental definitions:

 
Firms: The “firm” is the primary producing unit in an
economy. It’s an organization that transforms
resources (inputs) into marketable products (outputs).
(More informally, firms are known as companies).
 
Households: The “household” is the primary
consuming unit in an economy.
 
A circular flow diagram shows the interaction of
households and firms in the two basic kinds of
markets:

1) Product/Output Markets

2) Factor/Input Markets.
1) Product (or output) Markets are the markets in
which final goods and services are exchanged.

Final goods and services are consumer goods and

services that are intended for use by households.
 
Side Note FYI: Intermediate goods and raw
materials are goods supplied by firms to other
firms for further processing. In the circular flow of
economic activity, these two types of products are
also classified under output or product markets.
 
2) Factor (or input) Markets are the markets in which the
resources (factors of production) used to produce products
are exchanged.

They include:

a) Labor Markets, in which households supply labor to firms

that demand labor.
b) Capital Markets, in which households supply their savings
(for interest or for claims to future profits) to firms that
demand funds to buy capital goods.
c) Land Markets, in which households supply land or other
real property in exchange for rent, and firms demand this
land for production purposes.
So now, equipped with the above terms, we can
redefine who “demands” and who “supplies” as
follows:
 
In output markets, firms always supply and
households always demand.
 
In factor markets, it’s the other way around: firms
always demand and households always supply.
In other words, the origin of all labor, all land, and
all capital (finance) are the households. The
firms demand these FOPs in labor markets, land
markets, and capital (or financial) markets such
as the banking sector, the stock market, and the
bond market.

Firms pay the households for these FOPs. They pay

them wages/salaries, rent, interest, and
dividends.
Terms you need to know:
 
Capital: Economists define capital in a physical sense as
goods used (for longer than one year) to produce other
goods or services, or to create future value in any other
form. In the circular flow diagram, the term capital is
used to refer to financial capital (money) that will be used
to create the physical capital as defined by economists.
 
Investment: Economists define investment as the act of
producing or purchasing capital goods (as defined above).
To undertake investments firms normally need to raise
funds either by borrowing directly from a bank or by
selling financial securities in financial markets.
Terms you may want to know (FYI for now):

Bank Loan: The easiest and most frequently used

way for firms to obtain funds in order to build or
expand some productive activities (activities that
produce goods or services). When firms borrow
from the banks, they pay an interest. The interest
is then passed on to the households who
originally provided the funds after the bank takes
a portion for itself (bank’s profit).
Bond: This is one way for a company or a government
to raise funds in the financial markets. It is a prime
example of what is called “debt financing”. A bond is
issued by a firm or government in order to borrow
money from private citizens (usually through special
financial institutions called investment banks).

The reward to the private citizen or the bank is the

interest paid on the bond at regular intervals. Bonds
can be of various terms (typically 1, 3, 5, or 10 years).
Some government bonds are even for longer terms
(ex. 30 years). Bonds can have interest rates that
range anywhere from 3% to 10% (typically).
As an FYI, the bond market here in Lebanon is
confined to the bonds issued by the Lebanese
government. In countries with more
advanced financial markets bonds are issued
by both the government (government bonds)
and established firms (IBM, Intel, Microsoft,
GM, GE, Ford, etc.). Bonds issued by firms are
called corporate bonds.
Stock: This is another way for a company (but not a
government) to raise funds. A stock issued by a firm
can be bought by the general public or by organizations
(such as retirement funds). A stockholder will own a
share of the company according to how many stocks
he/she purchases. That’s why another term for
stockholder is “shareholder”. Raising funds through
stock sales is known as “equity financing”.

Stocks provide their holders with returns in the form of

“dividends” (a share of the profit agreed upon at the
end of each year by the collective body of
stockholders).
Also, stocks can be resold (in the stock market). When the
value of a stock has appreciated (increased) that’s
another important return to the stockholder. Most
stock buying throughout the world is done for the
purpose of earning a return in this form.

Example: You buy a stock of the giant American

corporation Intel (the world leader in microprocessor
technology and computer chip manufacturing). Intel
does well that year and earns good profits. Its shares
appreciate in the New York stock exchange. You earn a
return when you sell the share (or shares) for a higher
amount than originally bought.
Part Two – The Market Model
Sx
Px

Dx

Qx
The above shows a preview of this model for a
typical consumer good X.

The quantity (Q) is plotted on the x-axis. Price (P)

per unit is plotted on the y-axis.

There’s a downward sloping line (curve) labeled D

(for demand) and an upward sloping curve
labeled S (for supply). Where the two lines
intersect is the equilibrium quantity and price.
The equilibrium price is also referred to as the
“market-clearing price”.

Keep in mind that the price we’re talking about in

this model is the price (per unit) to be paid by
consumers or received by producers in the
market.

When it’s the equilibrium price then it’s the price

that is actually prevailing in the market (meaning
the price that’s paid and received).
Note that the model that we will discuss here
considers the case of a typical consumer good (or
service) X. In this case, the demand comes from
households (who are the consumers) and the
supply comes from firms (who are the
producers).

But keep in mind that supply and demand curves

are also used to discuss factor markets. In that
case, the demand would be from firms, and the
supply would be from households, so the roles of
consumers and producers are switched.
I. The Demand Side of the Model

This side looks at how consumers respond to changes in the price of

good or service X.
 
Definitions:

Demand is the relationship between price and quantity demanded for

a particular good or service under particular circumstances. From
that we derive the demand relationship (or demand curve), which
gives us the quantity the buyers want to buy at different prices.

The particular quantity that buyers want to buy at a particular price is

called the quantity demanded. The quantity demanded is a function
of the price.
Here is a typical "demand curve" based on
some arbitrary numbers. Assume the numbers
reflect cellular telephone calls, with the price (y-
axis) being price per call and the quantity (x-
axis) being number of calls demanded.
The demand curve tells us the following (for this
particular service, telephone calls)

If the price was 15$, there would be zero

demand. Nobody will demand any calls.

If the price was 10$, there would be a demand of

1 (phone call). If it drops further to 7$, the
demand would increase up to 3 calls.

And so on, and so forth.

There are individual demand curves, which depict the
relationship between price and quantity demanded for
an individual consumer (or household).

However, in economics, “demand curve” usually refers to a

market demand curve (unless otherwise stated). This is
the demand relationship that exists for a particular good
or service in the whole market. So we can speak of the
demand for computers, the demand for petroleum, the
demand for Toyota SUVs, the demand for dollars in
Lebanon, and so on, as representing the demand of all
the consumers in that particular market (in one city, in
one country, in the world, or whatever, depending on
the context).
Two important clarifications:
 
1) In economics, we distinguish between the terms
demand and want. We may “want” lots of things
and in unlimited quantities, but we “demand” only
those things that we have the ability and the
willingness to pay for.

Example: You may want to own a diamond ring, but if

you know you cannot afford to, then you cannot say
you have a “demand” for the ring. You may also
want to own a car, but if you’re willing to pay its
price, then you do have a demand for the car.
2) We distinguish between the terms demand (which is a
relationship or a schedule of price-quantity
combinations) and the quantity demanded (which is
specific for each price level).

The word demand refers to the willingness and ability of

people to purchase the good or service in the market at
different price levels. The demand relationship expresses
that willingness and ability for the whole range of prices.

On the other hand, the quantity that people want to buy

at a particular price is called the quantity demanded at
that price.
And, finally, as an FYI for clarification and for students
who are mathematically inclined:

Usually in math, we place the dependent factor on

the y-axis and the independent variable on the x-axis.
In this model by contrast, the quantity is the
dependent variable and the price is the independent
variable. In other words the quantity (consumer or
produced) depends on the price (and not the other
way around). So why isn’t the quantity on the y-axis
as it is usually done? This is purely a matter of
convention in the economics profession. It is more
useful this way for modeling purposes.
Here’s the same graph again:

Note that the demand curve intersects the X

axis. This is to indicate that even at a zero
price, there would be a limited demand
quantity (as this is constrained by human or
social capacity). Furthermore, the demand
curve intersects the Y axis. This shows that
at a high enough price, the quantity
demanded will eventually drop to zero.
[Usually when we draw a typical demand
curve for analysis we don’t have to show the
intersections with the x and y axis.]
The most important thing about the demand curve
is the fact that it’s downward sloping. Economists
call this the Law of Demand:

The law of demand simply states that as the price

of a good/service increases the quantity
demanded goes down, CETERIS PARIBUS (all else
equal). Similarly, as the price of a good/service
decreases, the quantity demanded goes up, again
ceteris paribus.
 
Ceteris Paribus
"Ceteris paribus" is a Latin phrase often used by
economists, literally meaning "other things equal."
Used in the context of an economic model, it means all
the variables that might affect the equilibrium in the
model are held constant. Only one variable is allowed
to change at a time.

We say that the law of demand applies "ceteris paribus,"

meaning that other things that might also influence
demand, such as the consumers' income, population,
and prices of other relevant goods are treated as being
constant. If those things change, the whole curve shifts.
Shifts in Demand:
Here is a figure to illustrate an increase in demand. The demand
curve shifts from D1 to D2. With the new demand curve, there is a
greater quantity demanded at every price. This is what is meant
by an increase in demand. The demand curve shifts to the right.

By contrast, a
decrease in
demand at every
price level would
be a shift of the
curve to the left.
Again, remember:

A change in demand is not the same as a change in the

quantity demanded. A higher price causes a lower
quantity demanded. Similarly, a lower price causes a
higher quantity demanded. Both of these represent
movements along the demand curve.

On the other hand, changes in any of the determinants

of demand (other than price) cause a change in
demand, or a shift of the entire demand curve (like
from D1 to D2 in the example above).
 
What are the major “non-price” determinants of
demand that cause the whole demand curve to
shift?

[In other words, when we say “all else equal”,

what are we talking about?].

Below are the five main (economically relevant)

determinants of demand. They are often
referred to as “shift parameters” of demand
because they cause the whole curve to shift.
1. A change in income (Y):

This may be the income of the individual consumer (if this is an

individual demand curve).

Most often it refers to the change of income of all the consumers

in one market (if we’re dealing with a market demand curve).

[An overall income increase may occur, for example, when the
country experiences economic growth, which is very relevant if
we’re dealing with a demand in a certain country/economy.]

In economics, we denote income by Y.

Typically, an increase in income causes an increase
in the demand (shift right) for a particular good,
and a decrease in income causes a decrease in
demand (shift left).

So, in notations:

Y ↑ → more will be demanded at every price →

the demand curve shifts right

Y ↓ → less will be demanded at every price →

the demand curve shifts left
FYI-- We call goods/services that behave
according to this typical pattern “normal
goods”.

In some cases (called “inferior goods”), an

increase in income may actually cause a
decrease in the demand for a particular good.
Examples: our demand for fast food declines as
our income increases since we will demand
higher quality food. Our demand for bus rides
decreases as our income increases, since we
will then prefer to ride private cars.
2. A change in the population of consumers.

Populations may increase at normal rates (due to

natural birth).

They may also change abnormally due to

migration. For example, the population in
Lebanon has increased significantly over the last
several years due to the Syrian refugee crisis. This
has caused an increase in the demand for
consumer goods and services in the country.
To summarize:

Pop ↑ → more will be demanded at every price

→ the demand curve shifts right

Pop ↓ → less will be demanded at every price

→ the demand curve shifts left
FYI: One of the sectors that have been most
heavily impacted by this change is the market
for apartments (the real estate sector). The
rise in population has increased dramatically
the demand for residential units and (as we will
later understand) has raised the average price
of these units (as well as the average monthly
rents).
3. Changes in the prices of related goods.

a) Complements: These are products we use in

conjunction with each other (together), such as
coffee and sugar, computer hardware and software,
camera and film, cars and gasoline.

If the price of a complement increases, the “quantity

demand” of that complement decreases. Therefore,
the “demand” for the good that is used along with it
decreases at every price. The opposite is true.
Therefore, to summarize (where comp stands for
complement and X stands for our good):

Pcomp ↑ → Dx shifts left (less is demanded at

every price level)

Pcomp ↓ → Dx shifts right (more is demanded at

every price level)
Here’s a good example to remember that:

Take car and gasoline. Gasoline is a complement

of car. If gasoline becomes more expensive
people will also drive less cars. Demand for
cars goes down. Alternatively, if gasoline
becomes cheaper people will be encouraged
to drive more cars. Demand for cars goes up.
b) Substitutes: These are rival products. If the
price of a substitute increases, then the
“quantity demanded” of that substitute
decreases. Therefore, the “demand” for the
alternative good would increase.

Examples include one brand of coffee vs another,

IBM vs Apple computers, Japanese cars vs.
American cars, Samsung vs I-phone, traveling
by bus vs. traveling by train, etc..
Therefore, to summarize: If the price of a
substitute of good x increases, people will
demand less of it and therefore the demand for
good x will increase at every price level. The
opposite is true: if the substitute becomes
cheaper people will demand it more, and
therefore, people will demand X less.
In notations, where sub stands for substitute:

Psub ↑ → Dx shifts right (more is demanded at

every price level)

Psub ↓ → Dx shifts left (less is demanded at every

price level)

As an example, if Samsung becomes cheaper, all

else equal, people will demand more Samsung
and less I-phone, and vice versa.
4. Changes in consumer tastes and preferences:

The demand for almost everything changes over time.

Some demands even disappear altogether while others
are created. This is because societies and cultural norms
change.

Primary examples include the demand for sportswear, the

demand for cellular phones, the demand for computers,
the demand for health foods, and hundreds of other new
products that keep appearing all the time.
Not only have demands been created for
modern technology gadgets such as computers
and cell phones, but demands have also been
created for new kinds of services (e.g.
childcare services, which have emerged with
the increasing involvement of women in labor
markets).
Changes in tastes and preferences are influenced by things
such as advertising, social changes, and information.

For example, any time new information becomes available

due to scientific or technological discoveries, consumer
behavior is likely to change.

In some cases, the demand increases due to information:

you demand more orange juice because you know that
Vitamin C plays an important role in health. In other
cases, the demand decreases due to information: the
demand for cigarettes has decreased dramatically in
advanced societies as more information emerged about
the health risks of smoking.
5. Changes in Expectations: This is often a more
important determinant than all the others, with
many price fluctuations observed in the real world
influenced not by current events but rather by future
expected events.

Consider the following examples: Why does the

world price of oil or gold change so much,
sometimes from day to day? Why does the exchange
rate of the dollar vs the Euro (i.e. the “price” of the
dollar in terms of Euro) change from day to day?
Today in Lebanon, why has the dollar rate been
changing in the black market with so much volatility?
Often, these changes occur even when there is no
underlying “current” supply or demand factor
causing them. The answer turns out to be
“expectations”. Note, again, that while the 4
demand factors discussed already (income,
population, tastes, and prices of other goods)
reflect things happening now, this last factor
(expectations) reflect things expected to happen
in the future.
If people expect a war to occur in the Middle East
(future event), they might increase their demand for
oil today.

If people expect the US economy to improve soon, they

might demand more dollar-based assets today (which
will increase the value of the dollar relative to other
major currencies).

Alternatively, if people expect the dollar to fall further,

the demand for gold may increase instead. Hundreds
of other events like that happen every day that
confirm the importance of expectations.
II. The Supply Side of the Model

Now we switch our attention to firms and how they respond

to changes in the price of the good they are producing.

The assumption is that each firm takes the price as given

(they are price-takers) and based on the price, they
determine how much to supply/produce. [More on that
on the next slide.]

 
At each price along the supply curve, the firm
(for the individual supply curve), or firms (for a
market supply curve), will produce/supply a
specific quantity.

Again, it is very important to bear in mind that

the prices we’re talking about here is the price
received (by the firms) in the market for each
unit of the product supplied/produced/sold.
So this curve says the following:

If the price in the market was 1$, firms would

supply 500 gallons.

If the price in the market was 1.40$, firms would

supply 600 gallons.

And so on, and so forth.

An important question arises here: If firms react to each
price by deciding how much they want to produce at
that particular price, then who sets the price in the first
place?

In answer to that, note that this model assumes a

perfectly competitive market in which there’s a large
number of firms producing the same good x. None of
these firms can change or manipulate the price which
is given by the market. In economic terminology we
say the firms are “price takers”. The market sets the
price.
[We will discuss these issues in greater length in coming chapters. For
now let’s accept this assumption in order to understand the basic
supply & demand model.]

Just like in the demand case, there are several primary facts to note
that we can summarize as follows:
 
– Supply decisions depend on profit potential.
– Profit is the difference between revenues and costs. We will talk about
cost in a later chapter, and revenue depends on the price.
– Quantity supplied represents the number of units of a product that a firm
would be willing and able to offer for sale at a particular price.
– A supply schedule is a table showing how much of a product firms will
supply at different prices.
– A supply curve is a graph illustrating how much of a product firms will
supply at different prices.
The law of supply states that there is a positive
relationship between price and quantity of a
good supplied CETERIS PARIBUS (all else equal).
This means that supply curves typically have a
positive slope.

Just like with the demand concept, when we use

the term "supply" we usually mean the entire
supply curve or relationship, while if we refer to
the specific quantity the firm(s) want to sell at a
specific price, we say the "quantity supplied."
Also like with the demand curve, a supply curve
can refer to the supply schedule of one
individual firm.

More commonly, however, the term “supply

curve” means the market supply curve (i.e. all
the firms engaged in the production of this
particular good or service in one city, one
country, all over the world, etc., depending on
the context).
Shifts in Supply:

Here too we can state the same concept like with

the demand curve, which is that price is the only
factor that causes movements along the curve. If
price increases, quantity supplied increases. If
price decreases, quantity supplied decreases.
 
Everything else other than price are factors that
would cause the whole supply curve to shift
either to the right (=an increase in supply) or to
the left (=a decrease in supply).
Here is a figure to illustrate an increase in supply. The supply curve shifts
to the right, from S1 to S2, so that the new supply curve shows a
greater quantity supplied at every price. That is what we mean by an
increase in supply.
The figure below, on the other hand, illustrates a decrease in supply. The
supply curve shifts to the left, from S1 to S2. The new supply curve
shows a smaller quantity supplied at every price, and that is what we
mean by a decrease in supply.

Like in the case of demand, we shall now list the five main (economically
relevant) determinants of supply. They can also be referred to as “shift
parameters” of supply because they cause the whole curve to shift.
Here are illustrations of right and left shifts of supply applied to the example of gasoline.
1. Changes in the cost of production.
 
This often comes from changes in the prices of
inputs required for the production of this good.

– Raw materials
– Labor, which constitutes the highest cost item for
most firms around the world
– Cost of energy (fuel, electricity, etc.), which is another
major input into the production process
In general, whenever the cost of inputs increase
(meaning a higher cost of production), the supply
curve of the good in question shifts to the left (or
you can say “shifts in”). This means that there will
be less of the good supplied at every possible price.

Recall that a higher cost of production means a lower

profit, which leads to a decreased incentive to
produce at every market price.

Conversely, if the opposite happens and costs of

production decrease the supply curve shifts right (or
you can say “shifts out”).
2. Changes in the available technologies of production.

An improvement in production technology causes the

supply curve to shift right. A good example would
be the growth in the computer (and related
hardware) industry due to the increased efficiency
and improved technology of production.

As another example, improved agricultural technology

leads to a greater supply of crops (and this has been
the leading factor for the massive increase in food
production around the world).
3. Change in the number of suppliers/producers.
When firms enter a (product) market as producers,
more will be supplied at all price levels; therefore,
the supply curve shifts to the right. Conversely, when
firms exit a market, the supply curve shifts to the left.
As always, this is how we understand things when all
else is held constant.

4. Changes in natural (or man-made) conditions

(relevant to the production of the good in question).
– Rainfall & weather in general
– Natural disasters
– Wars and/or political unrest (that may disrupt supply)
5. Changes in Expectations:

If producers expect good times ahead (robust

future demand) they would produce more
output today and/or more producers would join
their ranks today (again, all else equal) The
opposite is true if they expect bad times ahead
(depressed future demand).

In general, when bad conditions are expected the

supply curve shifts left, and when good
conditions are expected it shifts right.
III. Equilibrium of Supply and Demand

When two lines on a diagram cross, this intersection

usually means something. The point where the supply
curve (S) and the demand curve (D) cross, designated
by point E in the figures, is called the equilibrium.

The equilibrium price is the only price where the plans

of consumers and the plans of producers agree—that
is, where the amount of the product consumers want
to buy (quantity demanded) is equal to the amount
producers want to sell (quantity supplied). Economists
call this common quantity the equilibrium quantity.
At any other price, the quantity demanded does
not equal the quantity supplied, so the market is
not in equilibrium at that price.

You can also think of the equilibrium price as the

price at which there is no natural tendency for
further adjustment. The corresponding quantity
is the quantity that would be traded in the
market at that price.

Economists call this the “market-clearing price”.

What does it mean to say there is no natural
tendency for further adjustment? Why do we
call this an "equilibrium?"
 
Let's see what happens when price is not where
it should be in order to equate the quantities
supplied and demanded.
Price Too Low:
What we see here is
that the quantity
demanded exceeds
the quantity
supplied at the
price of $1.75. This
is a case of “excess
demand”. Thus,
demanders will
compete against
one another,
offering higher
prices for the
limited supply, and
the price will rise.
Price Too High:
Here we have excess
supply -- the
quantity supplied
exceeds the quantity
demanded at the
$3.00 price. Thus,
suppliers will
compete to sell
what they can by
cutting the price.
And one other example for the case of gasoline (again).
IV. Changes in Equilibrium
• Higher demand leads to higher equilibrium price
and higher equilibrium quantity. This is shown in
the diagram below.
• Higher supply leads to lower equilibrium price
and higher equilibrium quantity. This is shown in
the diagram below.

 
Similarly, in the opposite direction

• Lower demand leads to lower price and lower

equilibrium quantity

• Lower supply leads to higher price and lower

equilibrium quantity.

[As an exercise, practice drawing those last two

scenarios using similar diagrams like the ones
above.]
Relative Magnitude of Change
• What happens when both supply and demand curves
shift?

• The relative magnitudes of change in supply and

demand determine the outcome of market equilibrium
in this case.

• For example, when supply and demand both increase,

quantity will increase (definitely), but price may go up or
down.

• This is illustrated in the two figures below.

When the increase in
supply outweighs
(exceeds) the
increase in demand,
the price goes down.

The increase in
supply is a price-
reducing factor while
the increase in
demand is a price-
increasing factor.

The price-reducing
force is stronger so
price drops.
When the increase
in demand
outweighs (exceeds)
the increase in
supply, the price
goes up.

Again, the increase

in supply is a price-
reducing factor
while the increase in
demand is a price-
increasing factor.

The price-increasing
force is stronger so
price rises.
Addendum to Chapter 3 on the S/D Model

First– Summary

The three following slides present concise

summaries of shift factors.
Notes/Clarifications on Previous Slide:
• The bullets about “fall in input price” or “rise in input
price” are the same as decrease or increase in “cost of
production” that we discuss in class. The cost of
production comes from inputs such as labor, materials,
and fuel/electricity.
• The bullets about taxes of production are not discussed
in class. You can ignore them for now, but, in general,
they are related to the cost of production.
• The factor “number of suppliers/producers” is not
included on the graph, but we do discuss it in class. This
factor only applies to a market supply curve, whereas the
graph on this slide is for one single supplier.
Second: Real-World Applications

We do 3 applications in class. I will present herewith the

first one only: the case of the sale on winter clothes. The
two other applications were open-ended. You can do
them for yourselves as exercises. To refresh your
memory, they were about a) tuition at a major university
in Lebanon, and b) the $/LL exchange rate.

Tip: If you want to experiment with the second case of

exchange rate, just remember that the price axis will be in
LL/$ (how many liras per 1 dollar), and the quantity axis
will be in $s (demanded or supplied)
Case of Sales in March on Winter Sweaters (WS)
S

B
P*F

P*M
A

DF
DM
Explanation:
1) The demand curve shifted to the left in March to indicate a change in
consumer tastes and preferences.
2) Now we have a new demand curve (DM)
3) The supply curve is assumed to stay in same place as this represents the
behavior of shop owners
4) At the existing equilibrium price (P*F), a surplus will now emerge between the
existing supply (read off the supply curve) and the new demand (read off the
new demand curve).
5) To eliminate this surplus shop owners have to do sales.

Note that this example applies to all situations where the supply and/or the
demand curve shifts for any good or service. Basically, when the shift happens
(any shift), the pre-existing equilibrium price will no longer equilibrate the
market (SD). This will create either a surplus or a shortage (depending on
what has shifted and how). When this occurs, a new price will have to be
found through the forces of supply and demand. This happens automatically
in the market by prices going up or down as seen in a previous section before.