Demand, Supply and Market Equilibrium
Domain 2 tests whether you can distinguish a movement along a curve from a shift of the curve, and whether you can locate and interpret market equilibrium.
Demand
The law of demand states that, ceteris paribus, a rise in price reduces quantity demanded, giving a downward-sloping curve. Non-price determinants shift the curve: income, tastes and advertising, prices of substitutes and complements, population, and expectations of future prices.
Supply
The law of supply states that price and quantity supplied move together, because higher prices are needed to cover rising marginal costs. Shifters include input costs, technology, indirect taxes and subsidies, the number of firms and, in agriculture, weather.
Equilibrium and the price mechanism
Equilibrium occurs where quantity demanded equals quantity supplied. Above equilibrium a surplus pushes price down; below equilibrium a shortage pushes price up. Prices perform a rationing, signalling and incentive function.
Worked example
Let Qd = 120 - 3P and Qs = 20 + 5P. Setting them equal: 120 - 3P = 20 + 5P, so 100 = 8P and P = 12.50, giving Q = 82.5. If government imposes a price ceiling of N$10, Qd = 90 and Qs = 70, creating a shortage of 20 units and pressure for queues or black-market selling.
Traps that cost marks
- A change in the good's own price moves along the curve; it never shifts it.
- A rise in the price of a substitute shifts demand right; a rise in the price of a complement shifts it left.
- Ceilings set below equilibrium cause shortages; floors set above equilibrium cause surpluses.
- Shifts in supply change equilibrium price and quantity in opposite directions.