Suppose the market for Good X is in equilibrium. Explain the chain effect, if:

a) Increase in market demand is less than the decrease in market supply.

b) Increase in market demand is more than the increase in market supply.

When the demand good X is in equilibrium then demand is equal to the supply of good X. the equilibrium condition is depicted in the diagram. In the diagram, the equilibrium point is determined by E where the demand curve (DD) is tangent to the supply curve (SS). At equilibrium the price is P and the equilibrium quantity is Q.

a) When the increase in the market demand is greater than the decrease in market supply.

Increase in market demand will shift the demand curve to the right. The increase in demand is due to the change in other determinants such as income, the price of related variables etc. the decrease in the supply curve will shift the supply curve to the left. When the increase in demand curve is less than the decrease in the supply curve, it will increase the price of the good.

In the above diagram, the initial equilibrium is determined at the point E where the demand curve DD is tangent to supply curve SS. When the market demand increases the demand curve shifts from DD to D1D1. When there is a decrease in the market supply the curve SS shifts leftward that is S1S1. In the following case the increase in demand is less than the decrease in the supply curve, therefore, the new equilibrium point is determined at E1. In this case, there change in both price and quantity. But there will be a greater impact price. The price will increase from P to P1 and quantity decreases from Q to Q1. Increase in price is greater than the decrease in the quantity.

b) Increase in market demand is more than the increase in the market supply curve.

Increase in market demand will shift the demand curve to the right. The increase in demand is due to the change in other determinants such as income, the price of related variables etc. Increase in market supply will also shift the curve to the right.

When the increase in demand is more than the increase in supply curve the equilibrium shifted from E to E1. The shift in the equilibrium has an impact on both the price and quantity. Both the quantity a price has been increased but the increase in price is less than the increase in quantity. The increase in quantity is more in the case of an increase in market demand is more than the increase in market supply.