Demand, supply and price
In a market, the price mechanism uses demand and supply to set an equilibrium price. Changes in the conditions of demand or supply shift the curves and change price and quantity.
📌 Key points
- A market is where buyers and sellers exchange products; the price mechanism allocates resources through the interaction of demand and supply.
- Demand is the willingness and ability to buy a product at a given price. As price rises, quantity demanded falls (a contraction); as price falls, it extends.
- A change in the product’s own price causes a movement along the curve; a change in any other condition causes a shift of the curve.
- Demand shifts with changes in income, prices of substitutes and complements, tastes and fashion, advertising, population and taxes on income.
- Market demand is the total of all individual demands at each price.
- Supply is the willingness and ability to sell a product at a given price. As price rises, quantity supplied rises (an extension).
- Supply shifts with changes in costs of production, technology, weather (for crops), indirect taxes, subsidies and the number of firms.
- The equilibrium price is where demand equals supply. Above it there is excess supply, which pushes price down; below it there is excess demand, which pushes price up.
- An increase in demand raises equilibrium price and quantity; an increase in supply lowers price and raises quantity.
📖 Key terms
- Demand
- The willingness and ability to buy a product at a given price in a given time period.
- Supply
- The willingness and ability to sell a product at a given price in a given time period.
- Equilibrium price
- The price at which demand and supply are equal, so the market clears.
- Excess demand
- When quantity demanded is greater than quantity supplied at a price (a shortage).
- Excess supply
- When quantity supplied is greater than quantity demanded at a price (a surplus).
- Substitute
- A product that can be used in place of another, e.g. tea and coffee.
- Complement
- A product used together with another, e.g. printers and ink cartridges.
- Price mechanism
- The way changes in price allocate resources by acting as a signal and an incentive.
✏️ Worked example
In a coffee market, at a price of $4 per cup quantity demanded is 300 cups and quantity supplied is 500 cups. Explain what will happen to the price.
- Compare: quantity supplied (500) is greater than quantity demanded (300).
- So there is excess supply of 500 − 300 = 200 cups.
- Sellers have unsold coffee, so they cut the price.
- As price falls, quantity demanded extends and quantity supplied contracts.
- Answer: price falls until demand equals supply at the equilibrium price.
Use the right words: a change in the good’s own price causes an extension or contraction (movement along); anything else causes an increase or decrease (shift). Draw and label diagrams fully.
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