Robert J. Graham

Cheat Sheet / Updated 02-25-2022

Markets rely on participants engaging in mutually beneficial exchange. If participants are free to choose, they trade only if they perceive a personal gain. Thus, the consumer buys the goods and services that give them the most satisfaction relative to the price they pay, while businesses sell the goods and services that generate the most or maximum profit. Managerial economics develops business strategies that maximize profit.

Article / Updated 05-01-2017

Mastering managerial economics involves calculating values, with the ultimate goal of determining how to maximize profit. The usefulness of the price elasticity of demand depends upon calculating a specific value that measures how responsive quantity demanded is to a price change. Price elasticity of demand formula The formula used to calculate the price elasticity of demand is: The symbol η represents the price elasticity of demand. The symbol Q0 represents the initial quantity demanded that exists when the price equals P0. The symbol Q1 represents the new quantity demanded that exists when the price changes to P1. In this formula, the price elasticity of demand will always be a negative number because of the inverse relationship between price and quantity demanded. As price went up, quantity demanded went down, or vice versa. When price goes down, quantity demanded goes up. Price and quantity demanded always move in opposite directions, hence the price elasticity of demand is always negative. How to find price elasticity of demand: example problem Suppose that you own a company that supplies vending machines. Currently, your vending machines sell soft drinks at $1.50 per bottle. At that price, customers purchase 2,000 bottles per week. In order to increase sales, you decide to decrease the price to $1, and sales increase to 4,000 bottles. To calculate the price elasticity of demand, here’s what you do: Plug in the values for each symbol. Because $1.50 and 2,000 are the initial price and quantity, put $1.50 into P0 and 2,000 into Q0. And because $1.00 and 4,000 are the new price and quantity, put $1.00 into P1 and 4,000 into Q1. Work out the expression on the top of the formula. Start by dividing the expression on top of the equation. (Q1 – Q0) equals 2,000, and (Q1 + Q0) equals 6,000. Dividing 2,000 by 6,000 equals 1/3. Work out the expression in the bottom of the equation. (P1 – P0) equals –$0.50, and (P1 + P0) equals $2.50. Dividing –$0.50 by $2.50 equals –1/5. Do the final division of the remaining values on the top and bottom of the equation. Divide the top result, 1/3, by the bottom result, –1/5, to get the price elasticity of demand of –5/3 (or –1.67). So the price elasticity of demand for soft drinks equals The price elasticity of demand is simply a number; it is not a monetary value. What the number tells you is a 1 percent decrease in price causes a 1.67 percent increase in quantity demanded. In other words, quantity demanded’s percentage increase is greater than the percentage decrease in price. Thus, when you decrease the price of soft drinks, you will sell a lot more soft drinks, and your revenue will go up (from $3,000 to $4,000). Whenever the absolute value of demand is greater than one, price decreases will increase revenue.

Article / Updated 04-17-2017

Business executives face an economic dilemma in determining price: Customers want low prices, and executives want high prices. Markets resolve this dilemma by reaching a compromise price. The compromise price is the one that makes quantity demanded equal to quantity supplied. At that price, every customer who is willing and able to buy the good can do so. And every business executive who wants to sell the good at that price can sell it. The price that makes quantity demanded equal to quantity supplied is called the equilibrium price. It occurs where the demand and supply curves intersect. The equilibrium price for dog treats is the point where the demand and supply curve intersect corresponds to a price of $2.00. At this price, the quantity demanded (determined off of the demand curve) is 200 boxes of treats per week, and the quantity supplied (determined from the supply curve) is 200 boxes per week. Quantity demanded equals quantity supplied. How to determine the price mathematically You can also determine the equilibrium price mathematically. In order to determine equilibrium mathematically, remember that quantity demanded must equal quantity supplied. The demand for dog treats is represented by the following equation In the equation, QD represents the quantity demanded of dog treats, and P represents the price of a box of dog treats in dollars. Because a negative sign is in front of the term 50P, as price increases, quantity demanded decreases. The supply of dog treats is represented by The quantity supplied of dog treats is represented by QS in this equation, and P again represents the price for a box of dog treats in dollars. A positive sign in front of the 150P indicates a direct relationship exist between price and quantity supplied. To determine the equilibrium price, do the following. Set quantity demanded equal to quantity supplied: Add 50P to both sides of the equation. You get Add 100 to both sides of the equation. You get Divide both sides of the equation by 200. You get P equals $2.00 per box. This is the equilibrium price.

Article / Updated 03-26-2016

The cross-price elasticity of demand measures the responsiveness of a good’s demand to changes in the price of a second good. In managerial economics, this relationship is crucial because the amount of your good customers purchase is influenced by the prices rival firms charge for similar goods. Also, the price you charge for one good — hamburgers, for example — influences the amount you sell of a second good, french fries. How to determine the cross-price elasticity of demand Calculating the cross-price elasticity of demand requires determining how good x’s demand changes in response to a different price for good y. The cross-price elasticity of demand’s formula is Note how similar this formula is to other elasticity formulas. In this case, the symbol ηx,y represents cross-price elasticity of demand. The x represents the good whose quantity is changing, and the y represents the good whose price is changing. So, in the formula, the symbol Qx0 represents the initial demand or quantity purchased for good x when the price of good y is Py0. The symbol Qx1 represents good x’s new demand when good y’s price changes to Py1. As with all elasticity values, the larger the number (either positive or negative), the more flexible or responsive quantity is. For the cross-price elasticity of demand, a larger number indicates good x’s demand will change a lot when good y’s price changes. Your vending machine company currently sells soft drinks at $1.50 per bottle, and at that price, customers purchase 2,000 bottles per week. At the same time, a local convenience store sells the same soft drinks for $1.25 per bottle. The convenience store decides to run a special and lowers the price of soft drinks to $1.00 per bottle. As a result, your sales decrease to 1,800 bottles per week. You didn’t change the vending machine price for soft drinks, but your sales decreased due to the convenience store’s sale. The cross-price elasticity of demand will tell you how responsive your vending machine soft drink sales are to the change in price at the convenience store. Here’s what you do to determine how much the convenience store’s sale affects your demand: Because $1.25 is the initial price of soft drinks at the convenience store (good y), and 2,000 is quantity of soft drinks sold in vending machines (good x), put $1.25 into Py0 and 2,000 into Qx0. Because $1.00 and 1,800 are the new price for good y (convenience stores) and quantity for good x (vending machines), put $1.00 into Py1 and 1,800 into Qx1. Divide the expression on top of the equation. (Qx1 – Qx0) equals –200, and (Q1 + Q0) equals 3,800. Dividing –200 by 3,800 equals –1/19. Divide the expression in the bottom of the equation. (Py1 – Py0) equals –$0.25, and (Py1 + Py0) equals $2.25. Dividing –$0.25 by $2.25 equals –1/9. Divide the top result, –1/19, by the bottom result, –1/9. You get the cross-price elasticity of demand 9/19 or 0.474. So the cross-price elasticity of demand for soft drinks equals The cross-price elasticity of demand tells you a 1 percent decrease in the price of good y, the convenience store soft drink, causes a 0.474 percent decrease in demand for soft drinks from vending machines. Vending machine sales are not affected very much by changes in convenience store prices. Substitutes and complements Substitutes are goods that are used interchangeably — one is used in the place of another. Think of potato chips and pretzels. Thus, an increase in the price of one good, good y, causes an increase in the quantity consumed of the second good, good x. This change occurs because customers will tend to switch to the lower priced good. So, an increase in the price of potato chips, good y, means customers will switch and purchase more of good x, pretzels. Thus, a direct relationship exists between the price of good y and the demand for good x, and they are substitutes. Complements are goods that are used together, such as coffee and cream. For complements, an inverse relationship exists between good y’s price and good x’s demand; if good y’s price increases, the demand for good x decreases and vice versa. So, if the price of coffee increases, good y, you drink less coffee, and your demand for cream, good x, decreases. Finally, the larger the value, either positive or negative, for the cross-price elasticity of demand, the stronger the relationship between the two goods.

Article / Updated 03-26-2016

Supply describes the economic relationship between the good’s price and how much businesses are willing to provide. Supply is a schedule that shows the relationship between the good’s price and quantity supplied, holding everything else constant. Holding everything else constant seems a little ambitious, even for economists, but there is a reason for that qualification. By holding everything else constant, supply enables you to focus on the relationship between price and the quantity provided. And that is the critical relationship. The difference between quantity supplied and supply You must be able to distinguish between two terms that sound the same, quantity supplied and supply, but mean very different things. It is common for others not to make the distinction and as a result their analysis is confused. Quantity supplied refers to the amount of the good businesses provide at a specific price. So, quantity supplied is an actual number. Economists use the term supply to refer to the entire curve. The supply curve is an equation or line on a graph showing the different quantities provided at every possible price. How to graph supply The supply curve’s graph shows the relationship between price and quantity supplied. When the price is very high, businesses provide a lot more treats. There’s money to be made. But if the price is very low, there’s not much money to be made, and businesses provide fewer of the item. For example, if the price of dog treats is $5.00, businesses provide 650 boxes of treats a week. On the other hand, if the price of treats decreases to $1.00 a box, the quantity of treats provided decreases to 50 boxes a week. Price changes Price and quantity supplied are directly related. As price goes down, the quantity supplied decreases; as the price goes up, quantity supplied increases. Price changes cause changes in quantity supplied represented by movements along the supply curve. When the price of dog treats decreases from $5.00 to $1.00, the quantity supplied decreases from 650 to 50 boxes per week — a movement from point C to point D on the supply curve. This movement indicates that a direct relationship exists between price and quantity supplied: Price and quantity supplied move in the same direction. Supply curve shifts When economists focus on the relationship between price and quantity supplied, a lot of other things are held constant, such as production costs, technology, and the prices of goods producers consider related. When any one of these things changes, the entire supply curve shifts. If an increase in supply occurs, the curve shifts to the right. In this case, an increase in supply shifted the curve from S0 to S1. As a result, more dog treats are provided at every possible price. For example, at a price of $5.00, 750 boxes of dog treats are provided each week instead of 650. A rightward shift in the supply curve always indicates an increase in supply, while a leftward shift in the curve indicates a decrease in supply. The factors that shift the supply curve include Production costs: Input prices and resulting production costs are inversely related to supply. In other words, changes in input prices and production costs cause an opposite change in supply. If input prices and production costs increase, supply decreases; if input prices and production costs decrease, supply increases. For example, if wages or labor costs increase, the supply of the good decreases. Technology: Technological improvements in production shift the supply curve. Specifically, improvements in technology increase supply — a rightward shift in the supply curve. Prices of other goods: Price changes for other goods are a little complicated. First, in order to affect supply, producers must think the goods are related. What consumers think is irrelevant. For example, ranchers think beef and leather are related; they both come from a steer. However, customers don’t want to eat leather for dinner. Beef and leather are an example of joint products, products produced together. For joint products, a direct relationship exists between a good’s price and the supply of its joint product. If the price of beef increases, ranchers raise more cattle, and the supply of beef’s joint product (leather) increases. Producer substitutes also exist; using the same resources, a business can produce one good or the other. Corn and soybeans are examples of producer substitutes. If the price of corn increases, farmers grow more corn, and less land is available to grow soybeans. Soybeans’ supply decreases. An inverse relationship exists between a good’s price (corn) and the supply of its producer substitute (soybeans).

Article / Updated 03-26-2016

The diffusion of new technology introduces a crucial time element into managerial decision-making. You may be interested in how an innovation is going to affect your firm’s production costs over time. Or you may be interested in determining how diffusion occurs within your firm’s industry. Learning curve and diffusion models examine the relationship between time and technological change and provide you perspective on how technological change evolves. The learning curve for new technology Adopting an innovation doesn’t necessarily result in an immediate reduction in production costs. Often on-the-job experience is necessary before you can take full advantage of the innovation. Learning-by-doing results in decreasing production cost per unit as the cumulative output produced increases, and firms use the innovation more efficiently. The relationship between cumulative output and production cost per unit is described by a learning curve. It’s easy to mistakenly believe the new innovation’s adoption immediately leads to impressive gains in productivity and output. The day before the innovation, workers are using the old, inferior production method. The next day, the new production method leads to dramatic increases in productivity and lower production costs. But many productivity gains are only realized after an extended period of time. With the passage of time, further improvements in production techniques occur as greater experience is gained. This accumulated learning leads to additional refinements in both production and organization that support additional productivity gains that further reduce production costs. Given the learning curve, you may want to accept short-term losses in order to gain experience in producing a product. Setting a lower price encourages greater demand for the firm’s product, resulting in increased production. The learning-by-doing associated with the increased production results in lower per-unit cost on subsequent units produced, ultimately resulting in greater profits. By accepting an initial loss through low prices and high production, you can take advantage of the learning curve in a shorter period of time, ultimately resulting in greater profits overall. How to model diffusion to watch developments The speed with which an innovation is adopted by firms in an industry is influenced by a number of factors. The most profitable innovations are adopted first. In addition, innovations requiring a small investment are typically adopted more readily than innovations requiring a substantial investment. Iinnovations that have already been adopted by a large number of firms are more likely to be adopted by other firms due to increased information and competition. The relationship between diffusion, as measured by the percent of firms using an innovation, and time is often described by an S-shaped diffusion curve. Edwin Mansfield’s logistic curve often is used to describe this diffusion process. The formula for Mansfield’s logistic curve is where P(t) represents the percentage of firms using the innovation at time t. The symbol e (Euler’s number) approximates to 2.718. The parameters α and β describe the diffusion process, and they vary among innovations. The function described by the logistic curve is illustrated below. After you obtain data on the adoption of an innovation for previous years, you can estimate the logistic curve. After you estimate the curve, use it to predict the future diffusion path of the innovation. Firms have found that this technique has generated useful forecasts for the diffusion of a variety of innovations.

Article / Updated 03-26-2016

There are articles that say a dollar today is worth only 25 cents. The idea of the time value of money sounds somewhat absurd, and it is. But it’s really important to recognize what happens to money over time. A dollar today is worth — surprise — a dollar. However, a dollar today doesn’t buy as much stuff as a dollar did 30 years ago because of inflation. Given inflation, you would rather have a dollar right now, rather than a dollar ten years in the future. Even more important than inflation is the role interest plays in the value of money. If you have a dollar today, you can use it to buy a bond and earn interest. Thus, the dollar you have today will be $1.10 one year from now if the interest rate is 10 percent. Because of interest, you prefer receiving money now instead of in the future. In making business decisions, it’s important that you include the time value of money — the fact that money you hold today can earn interest. Thus, if you spend money today to build a new factory, you’re giving up the opportunity to earn interest. In the future, your factory generates profits — at least you believe it will — but you need to know whether or not those profits are large enough to offset the interest you lost by not buying a bond. This is determined by calculating the present value. The present value of money is the value of a future stream of revenue or costs in terms of their current value. Future revenues and costs are adjusted by a discount rate that reflects the individual’s time and risk preference. Often, the discount rate is some interest rate that represents the individual’s best alternative use for money today. The formula for calculating the present value of a future stream of net revenue — future revenues minus future costs — is where PV represents present value, Rt – Ct represents net revenue (revenue minus cost) in year t, r is the interest rate, and t is the year. Your company accepts a contract that has an anticipated net revenue of $100,000 at the end of each of the next three years. The interest rate is 6 percent. To determine the present value of this future stream of net revenue you take the following steps: Determine the present value of year one’s net revenue. Divide 100,000 by 1.06. Determine the present value of year two’s net revenue. Divide 100,000 by (1.06)2. Determine the present value of year three’s net revenue. Divide 100,000 by (1.06)3. Add the present value of net revenue for years one, two, and three. Thus, the present value of $100,000 net revenue for each of the next three years given an interest rate of 6 percent is $267,301.18. As an alternative to short-run profit maximization, managerial efforts can maximize the firm’s value. Focusing on maximizing the firm’s value can resolve the apparent conflict between the goal of immediate profit maximization and other goals, such as sales or growth maximization, that may increase the firm’s future profits. A firm’s value is defined as the present value of the firm’s expected future profit, ð. Therefore, where ðt represents the profit in year t, and r is the interest rate. This is simply a present value calculation that discounts profit earned in the future by the interest rate. A number of factors influence the firm’s value. The firm’s marketing department can increase profits through various marketing strategies. Costs are frequently reduced through the firm’s engineering or production department. Although research and development expenditures increase current costs and diminish current profits, they may result in higher future profits that more than offset those costs. Thus, maximizing the firm’s value encompasses a broad variety of strategies that you may employ as a manager. Your ultimate goal as manager is to maximize your firm’s value. That ensures that your destiny is a good one.

Article / Updated 03-26-2016

Oligopolies commonly compete by trying to steal market share from one another. Thus, rather than compete by lowering price — the kinked demand curve indicates that this tactic doesn’t work because everyone lowers price — firms often compete on the other factor that directly affects profit — the quantity of the good they sell. The Cournot model is used when firms produce identical or standardized goods and don’t collude. Each firm assumes that its rivals make decisions that maximize profit. The Cournot duopoly model offers one view of firms competing through the quantity produced. Duopoly means two firms, which simplifies the analysis. The Cournot model assumes that the two firms move simultaneously, have the same view of market demand, have good knowledge of each other’s cost functions, and choose their profit-maximizing output with the belief that their rival chooses the same way. With all these assumptions, you may wonder why not just assume the right answer. Unfortunately, it doesn’t work that way. On the other hand, you may think that these assumptions are unrealistic. However, research has shown that decision-makers operating in the same market over an extended period of time tend to have similar views of market demand and good knowledge of one another’s cost structure. Given these assumptions, one firm reacts to what it believes the other firm will produce. In other words, if firm B produces qB of output, what quantity should firm A produce? The Cournot reaction function describes the relationship between the quantity firm A produces and the quantity firm B produces. Here’s how it works. The market demand curve faced by Cournot duopolies is: where QD is the market quantity demanded and P is the market price in dollars. Assuming firm A has a constant marginal cost of $20 and firm B has a constant marginal cost of $34, the reaction function for each firm is derived by using the following steps: Note that the market quantity demand, QD, must be jointly satisfied by firms A and B. Thus, Substituting the equation in Step 1 for QD in the market demand curve yields For firm A, total revenue equals price multiplied by quantity. Firm A’s marginal revenue is determined by taking the derivative of total revenue, TRA, with respect to qA. Remember to treat qB as a constant because firm A can’t change the quantity of output produced by firm B. Firm A maximizes profit by setting its marginal revenue equal to marginal cost. Firm A’s marginal cost equals $20. Rearranging the equation in Step 5 to solve for qA gives firm A’s reaction function. Repeat Steps 3 through 6 to determine firm B’s reaction function. Remember that firm B’s marginal cost equals $34. Substituting firm B’s reaction function for qB in firm A’s reaction function enables you to solve for qA. Substituting qA = 76 in firm B’s reaction function enables you to solve for qB. Thus, in the profit maximizing Cournot duopolist, firm A, produces 76 units of output while firm B produces 48 units of output. In the Cournot duopoly model, both firms determine the profit-maximizing quantity simultaneously. In the last example, firms A and B had different marginal costs. If the firms have the same marginal costs (MCA = MCb), each firm produces half the market output.

Article / Updated 03-26-2016

An important piece of managerial economics, technological change alters the firm’s production function by either changing the relationship between inputs and output or introducing a new product and therefore a new production function. An improvement in technology enables your firm to produce a given quantity of output with fewer inputs shifting the production isoquant inward. This improvement in technology could be a new production technique, or it could result from organizational changes and improvements in management. Technological change that introduces new products are difficult to view as a shift in the production function. The new product simply has a new production function. When they were first introduced, there weren’t any goods comparable to computers, mircrowave ovens, and cellular telephones. When introduced, these new goods had their own, new production function. Technological change has three components — invention, innovation, and diffusion. Invention refers to a new device, method, or process developed from study and experimentation. According to the United States Patent and Trademark Office, an invention is “any art or process (way of doing or making things), machine manufacture, design, or composition of matter, or any new and useful improvement thereof, or any variety of plant, which is or may be patentable under the patent laws of the United States.” These definitions of invention exclude an important point. For business success, inventions must be economically viable — in other words, profitable. An innovation is an invention that’s applied for the first time. Although substantial evaluation occurs during the research and development process, innovation still entails a substantial degree of uncertainty regarding its profitability. This uncertainty can be removed only with the actual implementation of the innovation. After the innovation has been applied, reevaluation occurs based upon additional information obtained. The two types of innovations are product innovations and process innovations. Product innovation refers to the introduction of new and improved goods. For many, Wikipedia represents an improvement on printed encyclopedias. Both provide general information but Wikipedia makes it easier — and less costly — for many people to access that information. Process innovation refers to the introduction of new and improved production processes. Typically, process innovations enable you to manufacture a product more cheaply. Thus, process innovations focus on how things are done. An example of a process innovation is Henry Ford’s introduction of the assembly line in automobile production. Diffusion examines the speed at which an innovation is adopted. Diffusion seeks to explain how, why, and at what rate innovations are adopted. As a result, diffusion introduces a time element in your decision-making. How to measure labor productivity Determining the impact technological change has on your firm is important. Therefore, measuring technological change’s impact is necessary. Two such measures, labor productivity and total factor productivity, are based upon a comparison between the quantity of output produced and the amount of input employed. Technological change isn’t the only thing that changes labor and total factor productivity. For example, changes in input prices change the relative amounts of inputs you employ to minimize production costs. These changes in input quantities due to new input prices also change labor and total factor productivity. Labor productivity measures output per unit of input or, typically, output per labor-hour. An increase in labor productivity is frequently associated with an improvement in technology. Again, be careful when measuring technological change by using labor productivity, because technological change isn’t the only thing that influences labor productivity. For example, labor productivity is also affected by education, experience, motivation, and attitude of the worker. How to calculate total factor productivity An alternative measure of productivity is total factor productivity. Total factor productivity measures changes in output relative to changes in the quantity employed of all inputs. Use the following formula to calculate total factor productivity, represented by the symbol α: where q represents the firm’s quantity of output, I1 through In represent the quantity employed of inputs 1 through n, and p1 through pn represent the prices of inputs 1 through n. Suppose your firm produces 100,000 units of output. In order to produce that output, the firm uses 1,200 hours of labor, 600 machine-hours of capital, and 20,000 kilowatt-hours of electricity. If input prices are $10 per hour for labor, $5 per machine-hour for capital, and $0.04 per kilowatt-hour for electricity, you can use the following steps to calculate your firm’s total factor productivity: Substitute the quantity of output, 100,000, for q. For each input, insert the input price for p and the input quantity for I in the bottom of the equation. In the example, p1 is $10 and I1 is 1,200; p2 is $5 and I2 is 600; and p3 is $0.04 and I3 is 20,000. Calculate the value in the bottom of the equation. Divide the top of the equation by the bottom of the equation. So, total factor productivity equals If prices are held constant over time, changes in total factor productivity represent changes in the firm’s efficiency. Increases in total factor productivity represent improvements in a firm’s efficiency that result from technological change. Suppose five years ago, your firm produced 80,000 units of output by using 1,600 hours of labor, 500 machine-hours of capital, and 18,000 kilowatt-hours of electricity. If you hold input prices constant or the same as in the last example at $10 per hour for labor, $5 per machine-hour for capital, and $0.04 per kilowatt-hour for electricity, any change in the total factor productivity value results from changing input quantities. Using the same steps to calculate the firm’s total factor productivity: Substitute the quantity of output, 80,000, for q. For each input, insert the constant input price for p multiplied by the input quantity for I in the bottom of the equation. So, p1 is $10 and I1 is 1,600; p2 is $5 and I2 is 500; and p3 is $0.04 and I3 is 18,000. Calculate the value in the bottom of the equation. Divide the top of the equation by the bottom of the equation. So, total factor productivity equals Based on the two examples, total factor productivity in the last year is 152.1 percent (6.329/4.162) of the first year’s value. Alternatively, total factor productivity increased 52.1 percent over the five-year period.

Article / Updated 03-26-2016

Economic markets tend toward equilibrium, the price and quantity that correspond to the point where supply and demand intersect. But equilibrium itself can change. Because equilibrium corresponds to the point where the demand and supply curves intersect, anything that shifts the demand or supply curves establishes a new equilibrium. The illustration shows what happens when demand increases. Originally, the market was in equilibrium at price P0 and quantity Q0. If demand increases, the demand curve shifts to the right from D0 to D1. The quantity demanded associated with the price P0 is now QD. Because this is greater than the quantity producers are providing (still Q0 as determined off the supply curve), a shortage exists. The market moves from the original equilibrium price P0 to the new equilibrium price P1 and from the original equilibrium quantity Q0 to the new equilibrium quantity, Q1. The impact of an increase in supply is illustrated below. Originally, the equilibrium price and quantity are P0 and Q0, respectively. An increase in supply shifts the supply curve to the right from S0 to S1. The supply increase immediately creates a surplus because at P0, the new quantity supplied QS is greater than the quantity demanded, which is still at Q0. Because there is a surplus, the good’s price falls from P0 to the new equilibrium price P1, and the quantity demanded and quantity supplied move to the new equilibrium quantity Q1, which is greater than the original equilibrium quantity Q0. There are instances where both demand and supply shift at the same time, and this makes determining the changes in equilibrium price and quantity more difficult. When both demand and supply shift simultaneously, the change in only one equilibrium characteristic — price or quantity — can be definitely determined. The illustration below shows a simultaneous decrease in both demand and supply — the demand curve shifts left from D0 to D1, and the supply curve shifts left from S0 to S1. The original equilibrium price and quantity are P0 and Q0, corresponding to the intersection of the original demand and supply curves. Given the shifts to D1 and S1, the equilibrium quantity decreases from Q0 to Q1 while the equilibrium price has not changed — P0 = P1. But note that in this illustration, the demand and supply curves shift by the same amount. In the next illustration, two decreases in supply are illustrated along with the decrease in demand. The first decrease in supply is a relatively small one, from S0 to SA. The new equilibrium quantity decreases from Q0 to QA, and the equilibrium price also decreases from P0 to PA. The second decrease in supply is a relatively large one, from S0 to SB. In this case, the new equilibrium quantity still decreases, now from Q0 to QB. But note what happens to equilibrium price: It increases from P0 to PB. Given the decrease in demand, a small decrease in supply results in a lower equilibrium price, while a large decrease in supply results in a higher equilibrium price. These two illustrations show that when both demand and supply simultaneously decrease, equilibrium quantity always decreases, but equilibrium price can increase, decrease, or remain the same. So, only one equilibrium characteristic — equilibrium quantity — can be definitely determined. The crucial thing to note is that no matter what happens to supply and demand, the market always adjusts to its equilibrium point.