In a competitive market, what typically happens when there is a demand shock?

Question

BlackTom AI · Accepted Answer

When a demand shock hits a competitive market, the pressure on the demand curve causes a new intersection with the supply curve to form. This re-establishes equilibrium, but at a different price and a different quantity than before.
Option 1: 'Equilibrium price and quantity change.' This is consistent with standard microeconomic theory: a shift in the demand curve leads to a new equilibrium characterized by both a different price and a different quantity, depending on the direction and magnitude of the shock.
Option 2: 'Only quantity changes negatively.' This claims that quantity changes while price stays the same and that the change is negative. In a basic demand shift, the price typically adjusts as well to clear the market, so this option ignores the price mechanism and is therefore incorrect. The sign of the quantity change depends on the shock, but the assumption that price remains unchanged is unlikely in a demand shock.
Option 3: 'Only price changes positively.' This asserts a price change without any change in quantity and specifies a positive change. In most demand shocks, the market moves to a new equilibrium with both price and quantity adjusting; restricting change to price alone ignores the accompanying quantity adjustment and direction is not guaranteed to be positive for price in all cases.
Option 4: 'Equilibrium remains unchanged.' This would imply that a demand shock has no impact on the market outcomes, which contradicts the basic effect of a demand shift causing a new intersection with supply and thus a new equilibrium. In other words, the market does not stay static when demand shifts.

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