For this economics example, let’s focus on the apartments for rent in the Calgary market. If we assume
that this market is in equilibrium to begin with, then we can designate equilibrium
price and quantity with P* and Q* respectively.
Notice that in this market there is neither a shortage nor a surplus,
the market is in equilibrium. For this example, I am also assuming that the good in question is a normal good, not inferior.
Now if we have a change in people’s income --- the economy
gets better or income tax goes down --- everything else equal we will see an
increase in demand. Remember that an
increase in demand results in a rightward shift of the demand curve. As soon as the demand curve shifts to the
right, we are no longer in equilibrium at our current price and quantity (P*
and Q*).
You can see that there is a shortage in the apartments
market. This means that the old
equilibrium price is too low because there has been an increase in demand. Suppliers are willing to supply more
apartments, but only if they are able to charge a higher price. Because of this, the price of apartments will
rise until the quantity demand goes down a little bit, and the quantity
supplied increases.
Over time, we will see prices and quantities rise until we
reach the point where the new demand curve crosses the original supply
curve. This will result in a new
equilibrium price and quantity that we can designate P2 and Q2, note that both
have gone up as a result of an increase in income.
We could do a similar analysis for the apartment market if
income were to fall. Income could fall
either due to a poor job market and wages going down, or possibly due to an
income tax increase. If income were to
fall, we would see a decrease in demand – everything else equal. A decrease in demand would cause the demand
curve to shift to the left.
After this change in demand, there would be a surplus of
apartments at the original equilibrium price.
This would cause the price of apartments to fall, and slowly the
quantity demanded of apartments would rise, and the quantity supplied of
apartments would fall. Eventually the
price would fall enough so that the quantity demanded of apartments would be
equal to the quantity supplied of apartments, and there would neither be a
surplus nor shortage.
