Special Cases of Equilibrium
We have studied the effect of change in demand and supply on the equilibrium price and equilibrium quantity when demand and supply curves are of normal shape i.e. negatively sloping demand curve and positively sloping supply curve. In this blog we will study:
1. The effect of change in supply when demand curve is either :
- Perfectly Elastic or
- Perfectly Inelastic
2. The effect of change in demand when supply curve is either:
- Perfectly Elastic or
- Perfectly Inelastic
1. Effect of Change in Supply when Demand is Perfectly Elastic
A demand is said to be perfectly elastic when consumers are prepared to purchase all that they can get at a particular price but nothing at all at a slightly higher price, then price elasticity of demand for a commodity is said to be infinite.
A demand curve of infinite elasticity, is parallel to X – axis, illustrates perfectly elastic demand.
A change in supply either it is increase or decrease, results in a change in equilibrium quantity, but the price remains the same.
Original equilibrium is determined at point E, when the perfectly elastic demand curve DD and the original supply curve SS intersect each other. OQ is the equilibrium quantity and OP is the equilibrium price. The change may be either an “increase in Supply” or “Decrease in Supply”.
1. Increase in Supply:
When supply increases, the supply curve shifts to the right from SS to S1S1.
Increase in Supply when Demand is Perfectly Elastic
For perfectly elastic demand, the demand curve DD is a horizontal straight line parallel to the X- axis.
As the supply increases, supply curve SS shifts towards right to form S1S1 and a new equilibrium point is obtained at E1.
Since demand curve is horizontal straight line, equilibrium price remains constant at OP.
Equilibrium quantity rises from OQ to OQ1.
2. Decrease in Supply:
Decrease in Supply when Demand is Perfectly Elastic
For perfectly elastic demand, the demand curve DD is horizontal straight line, parallel to X- axis.
When supply decreases, supply curve shifts toward left, from SS to S2S2.
There is a new equilibrium established at point E2.
Equilibrium price remains constant at point OP due to perfectly elastic demand. But equilibrium quantity falls from OQ to OQ2.
2. Effect of Change in Supply When demand is Perfectly Inelastic:
The demand for a commodity is said to be perfectly inelastic, when quantity demanded of a commodity does not respond to a change in its price.
In this case the quantity demanded remains the same, irrespective of any rise or fall in the price of the commodity.
The demand curve, for perfectly inelastic demand is a vertical straight line, parallel to Y- axis.
Any change in supply, either increase or decrease, brings about a change in price only, but the equilibrium quantity remains the same.
1. Increase in Supply:
Increase in Supply when Demand is Perfectly Inelastic
For a perfectly inelastic demand the demand curve DD is vertical straight line parallel to Y- axis.
As the supply of the given commodity increases, the supply curve SS shifts rightward to form S1S1. As a result a new equilibrium point is established at point E1.
Equilibrium price falls from OP to OP1 but equilibrium quantity remains the same at OQ as demand is perfectly inelastic.
2. Decrease in Supply:
Decrease in Supply when Demand is Perfectly Inelastic
For perfectly inelastic demand, demand curve DD is a vertical straight line parallel to Y- axis.
When supply of a commodity decreases, the supply curve shifts leftward from SS to S2S2. A new equilibrium point is determined at point E2.
Equilibrium price rises from OP to OP2 but equilibrium quantity remains constant at OQ since demand is perfectly inelastic.
3. Effect of Change in Demand when Supply is Perfectly elastic:
Perfectly elastic supply represents a case in which the quantity supplied of a commodity responds by an infinite amount to a very small change in price. When supply is perfectly elastic, the sellers are prepared to sell an infinitely large quantity of a commodity at a given price, but nothing would be supplied at all at a slightly lower price.
Supply curve for perfectly elastic supply is a horizontal straight line, parallel to X – axis.
Any change in demand whether it is increase or decrease, results in change in equilibrium quantity only, but the price remains the same.
1. Increase in Demand:
Increase in Demand when Supply is Perfectly Elastic
In the given figure, DD is the original demand curve, while SS is a perfectly elastic supply curve, intersecting at point E to form equilibrium point E. Here OP is equilibrium price and OQ is equilibrium quantity corresponding to point E.
When demand increases, the demand curve shifts to right from DD to D1D1.
Since supply is perfectly elastic, supply curve SS is parallel to X- axis.
Due to increase in demand for a commodity, the new equilibrium is established at E1.
Equilibrium quantity rises from OQ to OQ1 but equilibrium price remains the same at OP as supply is perfectly elastic.
2. Decrease in Demand:
Decrease in Demand when Supply is perfectly Elastic
In the given figure, when the demand for a commodity decreases, the demand curve DD shifts rightward to form a new curve D2D2. Hence there is a new equilibrium point is established at point E2.
Since the supply is perfectly elastic, supply curve is parallel to X axis, there is no change in equilibrium price, it remains same at OP, while te equilibrium quantity falls from OQ to OQ2.
4. Effect of Change in demand when Supply is Perfectly Inelastic:
The supply for a commodity is said to be perfectly inelastic when there is no supply response, no matter how large a price change takes place.
It means, that quantity supplied of a commodity does not change with the change in price.
Perfectly inelastic supply curve is a vertical straight line parallel to Y -axis. Any change in demand whether it is increase or decrease brings about a change in equilibrium price, but the equilibrium quantity remains the same.
1. Increase in Demand:
Increase in Demand when Supply is perfectly Inelastic
In the given figure, demand curve DD, intersects the perfectly inelastic supply curve SS to form an equilibrium point E, where equilibrium price and quantity are OP and OQ respectively.
When there is increase in demand, demand curve DD shifts rightward to form another curve D1D1.
There is a new equilibrium point determined at E1.
Since supply curve is a horizontal straight line parallel to Y – axis, the equilibrium price rises from OP to OP1 but equilibrium quantity remains the same at OQ.
2. Decrease in demand:
Decrease in Demand when Supply is perfectly Inelastic
When demand decreases, the demand curve shifts leftward to form a new curve D2D2.
Since supply is perfectly inelastic, supply curve SS is vertical straight line parallel to Y – axis.
Intersection of D2D2 curve and SS curve establishes a new equilibrium point E2.
Since supply is perfectly inelastic and demand is decreased, the equilibrium price will fall from OP to OP2 but equilibrium quantity remains same at OQ.
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