Theme 1 · Topic 1.2 · Microeconomics
Demand, supply and market equilibrium
The single most useful diagram in the course. Get the demand and supply model secure here and most of Theme 1, and a good deal of the rest of the specification, becomes a matter of shifting one curve and reading off what happens.
Worked example This page shows the shape every topic guide follows: the idea, the diagram, the chain, the evaluation, and the key terms.
The idea
A market brings together the buyers of a good and its sellers. The demand curve shows the quantity buyers are willing and able to purchase at each price; it slopes downward because a lower price makes a good more affordable and better value relative to the alternatives. The supply curve shows the quantity firms are willing to offer at each price; it slopes upward because a higher price rewards production and covers rising marginal costs. Where the two curves cross, the market is in equilibrium: the quantity buyers want to buy equals the quantity firms want to sell, and there is no pressure on price to change.
The price at which quantity demanded equals quantity supplied, so the market clears with no shortage or surplus.
Keep one distinction watertight, because examiners test it constantly. A change in the good’s own price causes a movement along a curve. A change in any other condition, income, tastes, the price of a related good, costs of production, shifts the whole curve to a new position. Confusing the two is the most common way a good answer quietly goes wrong.
The diagram
The chain
Analysis marks (AO3) are earned by the links between steps, not by the diagram alone. Set out the reasoning so each step causes the next, with nothing assumed:
- Incomes rise, and for a normal good this increases the quantity demanded at every price.
- The demand curve therefore shifts to the right, from D₁ to D₂.
- At the old price P₁ there is now excess demand: buyers want more than firms are supplying.
- This shortage bids the price up; as price rises, firms extend supply (a movement along S) and some buyers are priced out (a movement along D₂).
- The market settles at a new equilibrium E₂, with a higher price P₂ and a higher quantity Q₂.
Evaluation
Now weigh it
Evaluation marks (AO4) come from judging the analysis, not repeating it. Push on the model’s assumptions and on magnitude:
- How much price rises rather than quantity depends on the price elasticity of supply: if supply is inelastic in the short run, most of the adjustment falls on price.
- The result assumes the good is normal. For an inferior good a rise in income would shift demand the other way, so the conclusion reverses.
- The model assumes other things equal. If costs are also changing, supply shifts too and the net effect on price and quantity is no longer clear-cut.
- Short run versus long run: supply is usually more elastic given time to adjust, so the price rise may be temporary.
Key terms
| Term | Precise definition | Where it earns marks |
|---|---|---|
| Effective demand | The quantity buyers are willing and able to buy at a given price in a given period. | Defining demand precisely (AO1); "able" rules out mere desire. |
| Movement along vs shift | A change in own price moves along the curve; a change in another condition shifts the whole curve. | The distinction that keeps an analysis answer accurate. |
| Excess demand | A shortage: at the current price, quantity demanded exceeds quantity supplied. | The mechanism that drives price back to equilibrium (AO3). |
| Equilibrium | The price and quantity at which the market clears and there is no tendency to change. | The anchor for every "what happens if..." question. |
Towards the exam
Write a short analysis: Using a demand and supply diagram, explain the likely effect of a fall in the price of a complementary good on the market for a product of your choice. Draw and label the diagram, then write the chain in full sentences, and finish with one evaluative point about what the size of the effect depends on.