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Demand

Demand: The quantity of goods/services consumers are willing and able to buy at a given price.

Both parts matter. Wanting a product is not enough on its own. Consumers must also have the money to pay for it, so demand only counts people who would actually buy at that price.

The demand curve

Demand curve: line drawn on a graph that shows how much of a good will be bought at different prices.

Price is plotted up the vertical axis, with quantity along the horizontal axis. The demand curve slopes down towards the right, which shows an inverse relationship: as the price rises, people buy less, and as it falls, they buy more.

Movement along the demand curve

A change in the price of the good itself causes a movement along the same demand curve. In the diagram, a fall in price from P1 to P2 moves the market from A to B, so the quantity demanded rises from Q1 to Q2. A rise in price would move it the other way.

Shifts in the demand curve

A change in any factor other than the good’s own price moves the whole demand curve to a new position.

The two ways a demand curve can shift:

• Increase in demand: the curve moves right, to D2. People buy more at each price, e.g. Q2 instead of Q1 at price P.
• Decrease in demand: the curve moves left, to D3. People buy less at each price, e.g. Q3 instead of Q1 at price P.

Factors that shift the demand curve

Substitute: An alternative bought/produced in place of something else.

Complementary goods: goods purchased together because they are consumed together.

Six factors that can shift the demand curve:

• Advertising: more advertising persuades more people to buy, so demand shifts to the right. A fall in advertising shifts it to the left.
• Income: when incomes rise, people can afford more, so demand for most goods shifts to the right. When incomes fall, it shifts to the left. For a few goods, called inferior goods, demand falls as incomes rise, e.g. cheap own-brand food, as people switch to more expensive brands.
• Fashion and tastes: when a product becomes more fashionable or popular, demand shifts to the right. When it goes out of fashion, demand shifts to the left. Tastes can be changed by things like celebrities or new health information.
• Price of substitute goods: if a substitute becomes cheaper, some consumers switch to it, so demand for the product shifts to the left. If a substitute becomes more expensive, demand shifts to the right.
• Price of complementary goods: if a complement becomes more expensive, demand for the product shifts to the left, e.g. dearer tennis rackets reduce demand for tennis balls. If a complement becomes cheaper, demand shifts to the right.
• Demographic changes: changes in the size or structure of the population. A bigger population, e.g. from a higher birth rate or immigration, increases demand for many goods. Changes in the age, gender, location or ethnic mix of the population change which goods are wanted, e.g. an ageing population needs more healthcare.

Each factor can shift demand either way, so the direction of the change matters. A rise in income shifts demand to the right, but a fall in income shifts it to the left.

Supply

Supply: The quantity of goods or services producers are willing and able to sell at a given price/at a given time.

Again, both parts count. A producer must want to sell at that price and must also be able to make or provide the goods.

The supply curve

Supply curve: shows how much of a good that producers are willing and able to supply at different prices over time.

The supply curve rises from left to right. When the price goes up, producers offer more for sale, and when it goes down, they offer less.

Why more is supplied at higher prices:

• More profit: a higher price lets existing firms earn more profit, so they are willing to produce more.
• New firms: a higher price attracts new firms into the market, as they also expect to make a profit.

Movement along the supply curve

A change in the price of the good itself causes a movement along the same supply curve. In the diagram, a rise in price from P1 to P2 moves the market from A to B, so the quantity supplied rises from Q1 to Q2.

Shifts in the supply curve

Any other change, such as a rise in production costs, moves the whole supply curve.

The two ways a supply curve can shift:

• Increase in supply: the curve moves right, to S2. Firms offer more for sale at each price.
• Decrease in supply: the curve moves left, to S3. Firms offer less for sale at each price.

Factors that shift the supply curve

Indirect taxes: taxes levied on spending, such as VAT.

Subsidy: money that is paid by a government or organisation to make prices lower, reduce the cost of producing goods or providing a service, usually to encourage production of a certain good.

Five factors that can shift the supply curve:

• Costs of production: e.g. wages, raw materials, energy and rent. If costs rise, each unit earns less profit, so firms supply less and the curve shifts to the left. If costs fall, it shifts to the right.
• Changes in technology: new technology makes production more efficient and lowers costs, so firms supply more and the curve shifts to the right.
• Indirect taxes: a tax adds to firms’ costs. Introducing or raising an indirect tax shifts supply to the left. Cutting or removing one shifts it to the right.
• Subsidies: a subsidy lowers firms’ costs, so a new or larger subsidy shifts supply to the right. Cutting or removing a subsidy shifts it to the left.
• Natural factors (natural disasters and weather): these matter most in farming. Good weather can bring a bigger harvest, so supply shifts to the right. Droughts, floods or hurricanes can destroy crops and equipment, so supply shifts to the left.

As with demand, the direction matters. A rise in an indirect tax shifts supply to the left, but a cut shifts it to the right.

Market equilibrium

Equilibrium price: the price at which the quantity supplied equals the quantity demanded.

The amount bought and sold at this price is the equilibrium quantity. On a diagram, both are found where the demand and supply curves cross, shown as Pe and Qe.

At the equilibrium price, producers sell everything they want to sell, and every consumer who wants to buy at that price can do so. Nothing is left unsold and there is no shortage, so it is also called the market clearing price. At any other price, the two quantities differ, so there is no equilibrium.

Shifts in demand and supply

When the demand or supply curve shifts, the market moves to a new equilibrium, with a new price and a new quantity.

The four possible shifts:

• Increase in demand: demand moves right. Price and quantity both rise.
• Decrease in demand: demand moves left. Price and quantity both fall.
• Increase in supply: supply moves right. Price falls and quantity rises.
• Decrease in supply: supply moves left. Price rises and quantity falls.

For example, when demand increases, there is a shortage at the old price P1, so producers can charge more. The higher price encourages producers to supply more, until a new equilibrium is reached at P2 and Q2.

Sometimes demand and supply both change at once, e.g. demand rises while supply falls. The price will rise, but quantity could go up or down, depending on which shift is bigger.

Drawing a shift diagram

What a shift diagram needs:

• Both axes labelled, price and quantity
• The original demand and supply curves, with the original equilibrium marked (P1 and Q1)
• Only the curve affected by the change shifted, in the right direction, e.g. a subsidy moves supply, not demand
• The new curve labelled, e.g. D2 or S2
• The new price and quantity (P2 and Q2) marked on the axes

Excess demand and excess supply

Excess demand: where demand is greater than supply and there are shortages in the market.

Excess supply: where supply is greater than demand and there are unsold products in the market.

When each one happens:

• Price below equilibrium: consumers want to buy more than producers want to sell, so there is excess demand. Goods sell out and some buyers go without.
• Price above equilibrium: producers want to sell more than consumers want to buy, so there is excess supply. Goods are left unsold.

To show either one on a diagram, draw a line across at the price, P1. Read off the quantity demanded (Qd) from the demand curve and the quantity supplied (Qs) from the supply curve. The gap between Qd and Qs is the excess demand or excess supply.

Calculating excess demand and excess supply

The two calculations:

• Excess demand: quantity demanded – quantity supplied.
• Excess supply: quantity supplied – quantity demanded.

How market forces remove excess demand and excess supply

Market forces: supply and demand, as well as how they determine the allocation of scarce resources and price.

When a market is left to itself, the price changes until the excess disappears and the market is back in equilibrium.

Removing excess demand

When demand is greater than supply, there are more buyers than goods, so producers can raise the price.

As the price rises:

• The quantity demanded falls, as some buyers are put off
• The quantity supplied rises, as producers are willing to sell more at a higher price

The price keeps rising until the two quantities are equal at the equilibrium price. Producers could also remove a shortage by using more resources to increase supply.

Removing excess supply

When supply is greater than demand, producers are left with unsold stock, so they lower the price.

As the price falls:

• The quantity demanded rises, as more consumers are willing to buy
• The quantity supplied falls, as producers are less willing to sell at a lower price

The price keeps falling until the market clears at the equilibrium price. Producers could instead store the extra goods and sell them later, but storage costs money and does not work for goods that go off quickly, such as fresh food.