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2 Revision – Demand and supply

Demand: The willingness and ability of a consumer to purchase a quantity of
a good or service at a certain price (in a given time period).
Supply: The willingness and ability of a producer to produce a quantity of a
good or service at a certain price (in a given time period).
Law of demand: As the price of a good falls, the quantity demanded will
normally increase. (The demand curve usually slopes downwards, ceteris
paribus).
Law of supply: As the price of a good rises, the quantity supplied will
normally rise. (The supply curve usually slopes upwards, ceteris paribus).
Ceteris paribus: An assumption that means ‘all other things being equal’.

Demand and the price of the good or service Normal demand curve

Price ($)
A change in the price of the product itself will lead to a
change in the quantity demanded of the product, i.e. a movement Movement along
the D curve
along the existing demand curve. The phrase ‘change in the
P1
quantity demanded’ is important, since it differentiates a
P2
change in price from the effect of a change in any of the other
determinants of demand. (See the diagram on the left below.)
D
0 Q1 Q2
The determinants of demand Quantity
There are a number of factors that determine demand and lead to
an actual shift of the demand curve to either the right or the
left. Whenever we look at a change in one of the determinants,
we always make the ceteris paribus assumption.
Income: Changes shift the demand curve. Outcome depends on
whether the goods are normal or inferior.
Price of other goods: Changes shift the demand curve. Outcome
depends on whether the products are substitutes or complements.
Tastes: Changes shift the demand curve. Outcome depends on
whether the change is in favour of or against the product.
Price ($)

Caused by: Caused by:

• a fall in price of a substitute • an increase in price of a substitute
• an increase in the price of a complement • a fall in the price of a complement
• a fall in income for a normal good • an increase in income for a normal good
• an increase in income for an inferior good • a fall in income for an inferior good
• a change in tastes against of the product • a change in tastes in favour of the product

D1 D2 D3
0
Quantity

Other factors: There are larger factors where changes that may
also shift the demand curve, such as changes in the size of the
population, changes in income distribution, changes in
government policy and seasonal changes.

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 Revision ● Demand and supply

Supply and the price of the good or service

A change in the price of the product itself will lead to a
change in the quantity supplied of the product, i.e. a movement
along the existing supply curve. The phrase ‘change in the
quantity supplied’ is important, since it differentiates a change in
price from the effect of a change in any of the other determinants
of supply.
Price ($)

Movement along S
the supply curve
P2

P1

0 Q1 Q2
Quantity

The determinants of supply

There are a number of factors that determine supply and lead to
an actual shift of the supply curve to either the right or the
left. Whenever we look at a change in one of the determinants,
we always make the ceteris paribus assumption.
The cost of factors of production: Changes shift the supply
curve. Outcome depends on whether the costs rise or fall.
Price of other products which the producer could produce
instead of the existing product: Changes shift the supply curve.
The state of technology: Changes shift the supply curve.
Outcome depends on whether the change improves or harms
productivity.
Government intervention: There are larger factors where
changes may also shift the supply curve, such as the imposition of
indirect taxes and the granting of subsidies.
Price ($)

Caused by: S1 S2 S3
• an increase in the cost Caused by:
of factors of production • a fall in the cost of factors of
• an increase in the price production
of other products the • a fall in the price of other
firm could supply products the firm could supply
• a worsening of • an improvement in technology
technology (unlikely) • the granting of a subsidy
• the imposition of an
indirect tax 0
Quantity

Equilibrium (the market mechanism)

When demand and supply come together, we get the creation of
the equilibrium market price and quantity. The equilibrium is self-
righting. If a firm tries to raise its price, then there will be excess
supply at the new price and price will fall back to the
equilibrium. In the same way, if a firm tries to lower its price, then
there will be excess demand at the new price and price will go
back up to the equilibrium.

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 Revision ● Demand and supply

Equilibrium Excess supply Excess demand

S1 S1

Price ($)
Price ($)

Price ($)
S1

P1

Pe Pe Pe

P1

D1 D1 D1
0 Qe 0 Q1 Q e Q2 0 Q1 Qe Q2
Quantity Quantity Quantity

The effect of changes in demand and supply

on the equilibrium

A shift of demand to the right

Demand shifts from D1 to D2. A shift of demand to the left
Demand shifts from D1 to D2.
This may be caused by a This may be caused by a
Price ($)

Price ($)
change in any of the change in any of the
S1 determinants of demand with S1 determinants of demand with
the exception of a change in the exception of a change in
P2 the price of the good itself, P1 the price of the good itself,
P1 which would simply lead to a P2 which would simply lead to a
movement along the demand movement along the demand
D2 curve and an eventual return D1 curve and an eventual return
D1 D2
to the equilibrium price. When to the equilibrium price. When
0 Q1 Q2 Q3 demand shifts, there will now 0 Q3 Q2 Q1 demand shifts, there will now
Quantity be a supply of Q at the Quantity be a supply of Q at the
1 1
equilibrium price, but a demand of Q3. Thus, there will be excess equilibrium price, but a demand of only Q3. Thus, there will be
demand of Q1Q3. This means that price will begin to rise. The excess supply of Q3Q1. This means that price will begin to fall.
process will continue until a new equilibrium is reached at P2 The process will continue until a new equilibrium is reached at
and Q2. More will be demanded and supplied at a higher price. P2 and Q2. Less will be demanded and supplied at a lower price.

A shift of supply to the right

Supply shifts from S1 to S2. A shift of supply to the left
Supply shifts from S1 to S2.
This may be caused by a This may be caused by a
Price ($)
Price ($)

change in any of the change in any of the

S1 S2 S2 S1 determinants of supply with
determinants of supply with
the exception of a change in the exception of a change in
the price of the good itself, the price of the good itself,
P1 P2
which would simply lead to a which would simply lead to a
P2 movement along the supply P1 movement along the supply
curve an eventual return to curve and an eventual return
D1 D1
the equilibrium price. When to the equilibrium price.
0 Q1 Q2 Q3 supply shifts, there will now 0 Q3Q2 Q1 When supply shifts, there will
Quantity be a demand of Q at the Quantity now be a demand of Q1 at
1
equilibrium price, but a supply of Q3. Thus, there will be excess the equilibrium price, but a supply of Q3. Thus, there will be
supply of Q1Q3. This means that price will begin to fall. The excess demand of Q3Q1. This means that price will begin to
process will continue until a new equilibrium is reached at P2 rise. The process will continue until a new equilibrium is
and Q2. More will be demanded and supplied at a lower price. reached at P2 and Q2. Less will be demanded and supplied at
a higher price.

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