In an actual situation, a change in price following a change in demand can also affect the supply of the commodity and vice versa. Therefore, it is essential to examine the effect of change in both demand and supply together on the equilibrium price of a commodity.
Let us start with a situation when the supply of a commodity X is constant but its demand increases. This increase in demand will result in a rise in the price of X. however; supply may also increase at the same time. If the increase original level; if the increase in supply equals the increase in demand, the equilibrium price will be back to its original level and if the increase in supply is less than the increase in demand, the equilibrium price will rise but it will still be less than the increase in price which resulted from an increase in demand.
Similarly, if the demand falls and supply of X remains constant, the equilibrium price will fall. The sellers will now incur losses and after some time will reduce the supply of X. as a result of this, price will again rise from this position. The exact rise in price will be determined by the extent to which supply of X is reduced following a decrease in its demand.
On the other hand, if the demand for X remains constant and supply is increased, the equilibrium price will fall. But a fall in price will increase the demand and the price will rise once again.
D1D1 is the original demand curve and S1S1 is the original supply curve. The equilibrium price in this case is OP1 where the quantity demanded and supplied are both OQ1. Now, following an increase in demand, the demand curve shifts upwards to D2D2 and the new equilibrium takes place where the price is OP2. The quantity demanded and supplied are both OQ2 at this price. As a result of this rise in price, supply increases and a new supply curve S2S2 emerges. The new equilibrium takes place where S2S2intersects D2D2 and the price now comes down to OP3. Since the supply increase more than demand, the new equilibrium price is less than the original price (OP1). The equilibrium quantity of demand and supply is PQ3.
Following an increase in the price of the commodity, whether the increase in supply will be higher or lower than the increase in demand will depend upon the cost of producing the additional units for supply. If an increase in production results in a rapid increase in costs, addition to supply will not take place at a fast pace. But if the costs fall with production of the additional units, the sellers will be prepared to supply large quantity of good as this would bring those higher profits.
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