Price changes | IGCSE Class 10 Economics Notes

This note covers the causes of price changes in a market (shifts in demand and shifts in supply caused by changing market conditions), how these shifts are shown on demand and supply diagrams, and their consequences for equilibrium price and the quantity bought and sold.

What is market equilibrium price and quantity?

In a competitive market, the market demand curve shows how much of a good all consumers together wish to buy at each price, and the market supply curve shows how much all firms together wish to sell at each price.

Market equilibrium is the situation where the plans of buyers and sellers match: the quantity that firms wish to sell exactly equals the quantity that consumers wish to buy, so the market clears.

The price at which this happens is the equilibrium price, and the amount bought and sold at that price is the equilibrium quantity.

Graphically, equilibrium is the point where the demand curve DD and the supply curve SS intersect, because that is the only point at which quantity demanded equals quantity supplied.

Definition: Market equilibrium. The situation in which, at the prevailing price, the quantity that buyers wish to buy equals the quantity that sellers wish to sell, so that there is no tendency for price to change.

Equilibrium condition = Qd = Qs states this formally: the equilibrium price p* is the price at which quantity demanded Qd(p*) equals quantity supplied Qs(p*).

What are excess demand and excess supply, and how do they cause prices to change?

If the price in a market is not at the equilibrium level, the market is out of balance. When market demand is greater than market supply at a given price, there is excess demand at that price.

When market supply exceeds market demand at a given price, there is excess supply at that price.

These imbalances are themselves a cause of price change. Where there is excess demand, some buyers are unable to obtain the quantity they want and are willing to pay more, so price tends to rise.

Where there is excess supply, some sellers are unable to sell the quantity they want, so they lower their price to attract buyers.

As price moves, quantity demanded and quantity supplied adjust (quantity demanded falls and quantity supplied rises as price rises, and vice versa) until the market reaches the point where the two are equal once more.

This automatic tendency for price to move towards equilibrium is sometimes described as the "invisible hand" at work in the market.

Definition: Excess demand. The amount by which quantity demanded exceeds quantity supplied at a given price; it tends to push price upward.

Definition: Excess supply. The amount by which quantity supplied exceeds quantity demanded at a given price; it tends to push price downward.

Excess demand = Qd − Qs and Excess supply = Qs − Qd at a given price; at the equilibrium price both are zero.

What distinguishes a shift of a curve from a movement along it?

It is important in economics to separate two different kinds of change. A movement along a curve happens only because price itself changes, with everything else held constant; it shows a change in quantity demanded or quantity supplied in response to price.

A shift in demand or a shift in supply is different: the whole curve moves to a new position because some condition other than price has changed, so that at every price the quantity demanded (or supplied) is now different from before.

It is these shifts, caused by changing market conditions, that are the underlying cause of a change in equilibrium price and quantity. A rightward shift means more is demanded or supplied at every price; a leftward shift means less is demanded or supplied at every price.

What causes the demand curve to shift?

The market demand curve is drawn on the assumption that factors other than the price of the good itself stay constant: the tastes and preferences of consumers, the prices of related commodities, the incomes of consumers and the number of consumers (the size of the market). When one of these changes, the demand curve shifts.

1. Change in income. For a normal good, demand increases (the curve shifts rightward) as consumers' income rises, because consumers can and wish to spend more on the good at every price. For an inferior good, consumers spend less on the good as income rises, so demand decreases.
2. Change in the number of consumers. If the number of buyers in the market increases, more of the good will be demanded at every price, shifting demand rightward; a fall in the number of buyers shifts demand leftward.
3. Change in tastes and preferences. A change that makes a good more desirable shifts demand to the right; a change that makes it less desirable shifts demand to the left.
4. Change in the price of a related good. A rise in the price of a substitute tends to increase demand for the good in question, while a rise in the price of a complement tends to reduce it.

Note that none of these factors is the price of the good itself; a change in the good's own price causes a movement along an unchanged demand curve, not a shift.

What causes the supply curve to shift?

The market supply curve is drawn holding technology, the prices of inputs used in production and the number of firms constant. A change in any of these shifts the supply curve.

1. Change in input prices. A rise in the price of an input used in production raises the cost of producing the good, so at every price firms are willing to supply less; the supply curve shifts leftward. A fall in input prices shifts supply rightward.
2. Technological progress. An improvement in technology allows firms to produce more output from the same inputs, lowering costs of production, so firms are willing to supply more at every price; supply shifts rightward.
3. Change in the number of firms. If more firms enter the market, market supply at every price rises, shifting supply rightward; if firms leave the market, supply shifts leftward.

As with demand, a change in the good's own price does not shift the supply curve; it causes a movement along it.

What happens to equilibrium price and quantity when demand shifts?

Starting from an initial equilibrium where demand curve DD0 and supply curve SS0 intersect, giving equilibrium price p0 and quantity q0, suppose the supply curve stays unchanged while demand shifts.

If demand shifts rightward, then at the old price p0 there is now excess demand, because quantity demanded at that price has risen while quantity supplied has not changed.

This excess demand pushes price up, and as price rises, quantity supplied rises and quantity demanded falls back, until a new equilibrium is reached at a higher price and a higher quantity than before.

If demand shifts leftward, then at p0 there is now excess supply, because quantity demanded at that price has fallen. This excess supply pushes price down, and the new equilibrium settles at a lower price and a lower quantity than before.

So whenever supply is unchanged, a shift in demand moves equilibrium price and equilibrium quantity in the same direction as the shift: both rise with a rightward shift in demand, and both fall with a leftward shift.

The horizontal axis shows quantity and the vertical axis shows price. The original demand curve DD0 and supply curve SS0 intersect at the original equilibrium point.

The demand curve shifts rightward to a new position DD1, while the supply curve SS0 stays where it is.

The new equilibrium point, where DD1 crosses SS0, lies above and to the right of the original equilibrium, showing a higher equilibrium price and a higher equilibrium quantity.

What happens to equilibrium price and quantity when supply shifts?

Now suppose demand stays unchanged while the supply curve shifts. If supply shifts leftward (for example because an input has become more expensive), then at the old equilibrium price there is excess demand, because quantity supplied at that price has fallen while quantity demanded has not changed.

Price is pushed upward, and the new equilibrium is reached at a higher price and a lower quantity than before.

If supply shifts rightward (for example because of technological progress or more firms entering the market), then at the old price there is excess supply, because quantity supplied has risen while quantity demanded has not.

Price is pushed downward, and the new equilibrium settles at a lower price and a higher quantity than before.

So whenever demand is unchanged, a shift in supply moves equilibrium price and equilibrium quantity in opposite directions: a rightward shift in supply lowers price but raises quantity, while a leftward shift raises price but lowers quantity.

Quantity is on the horizontal axis and price on the vertical axis. Demand curve DD0 is unchanged. The supply curve shifts leftward from SS0 to a new position SS1.

The new equilibrium, where DD0 crosses SS1, lies above and to the left of the original equilibrium point, showing a higher equilibrium price but a lower equilibrium quantity.

What happens when demand and supply shift at the same time?

Changing market conditions can affect both sides of the market together. There are four possible combinations of simultaneous shifts, and the effect on equilibrium price and quantity differs in each case.

When demand and supply shift in the same direction, the change in equilibrium quantity is certain (both curves pull quantity the same way), but the change in equilibrium price depends on the relative size of the two shifts and may go either way, or not change at all.

When demand and supply shift in opposite directions, the change in equilibrium price is certain, but the change in equilibrium quantity depends on the relative size of the shifts.

Quantity is on the horizontal axis and price on the vertical axis.

Both the demand curve and the supply curve shift rightward by amounts that happen to leave the equilibrium price unchanged, while the new equilibrium lies further to the right, showing a higher equilibrium quantity at the same price.

Going beyond the syllabus

How far equilibrium price and quantity move after a shift depends on the steepness of the demand and supply curves, which is linked to price elasticity of demand and supply (how responsive quantity demanded or supplied is to a change in price).

Flatter curves mean a given shift produces a larger change in quantity and a smaller change in price, while steeper curves mean a given shift produces a larger change in price and a smaller change in quantity.

Glossary

• Market equilibrium — the situation where quantity demanded equals quantity supplied at the prevailing price, so there is no tendency for price to change.
• Equilibrium price — the price at which quantity demanded equals quantity supplied.
• Equilibrium quantity — the quantity bought and sold at the equilibrium price.
• Excess demand — the amount by which quantity demanded exceeds quantity supplied at a given price.
• Excess supply — the amount by which quantity supplied exceeds quantity demanded at a given price.
• Demand curve — a line showing the quantity of a good consumers wish to buy at each price.
• Supply curve — a line showing the quantity of a good firms wish to sell at each price.
• Shift in demand — a movement of the whole demand curve caused by a change in a factor other than the good's own price.
• Shift in supply — a movement of the whole supply curve caused by a change in a factor other than the good's own price.
• Movement along a curve — a change in quantity demanded or supplied caused only by a change in the good's own price.
• Normal good — a good for which demand increases as consumers' income rises.
• Inferior good — a good for which demand decreases as consumers' income rises.
• Substitute good — a good that can be used in place of another, so that a rise in its price tends to increase demand for the other good.
• Complement good — a good used together with another, so that a rise in its price tends to reduce demand for the other good.

Common errors and misconceptions

• Misconception: any change in price is a "shift" of the demand or supply curve. Correct: a change in the good's own price causes a movement along a fixed curve; only a change in another factor (income, tastes, input prices, technology and so on) shifts the curve itself.
• Misconception: excess demand and excess supply are permanent features of a market. Correct: they exist only while price is away from equilibrium; the price mechanism tends to eliminate them by moving price towards equilibrium.
• Misconception: a rightward shift in demand always raises price by the same amount it raises quantity. Correct: the size of the change in price relative to quantity depends on the shapes of the demand and supply curves.
• Misconception: when both curves shift in the same direction, both price and quantity must change in that direction. Correct: the change in quantity is certain, but the change in price depends on the relative size of the two shifts and may go either way.
• Misconception: a fall in input prices raises price in the market for the good. Correct: a fall in input prices shifts supply rightward, which lowers equilibrium price and raises equilibrium quantity.
• Misconception: a normal good and an inferior good respond to income changes in the same way. Correct: demand for a normal good rises with income, whereas demand for an inferior good falls as income rises.
• Misconception: excess supply pushes price up. Correct: excess supply means sellers cannot sell as much as they want at that price, so they lower price, which pushes price down, not up.

Exam-style questions with model answers

Q1. Define 'excess supply'. [2 marks]

1. Excess supply is the amount by which the quantity that sellers wish to supply exceeds the quantity that buyers wish to buy at a given price.
2. It occurs when market price is above the equilibrium price.

Q2. Distinguish between a shift in the demand curve and a movement along the demand curve. [2 marks]

1. A movement along the demand curve is a change in quantity demanded caused only by a change in the good's own price, with the curve staying in the same position.
2. A shift in the demand curve is a move of the whole curve to a new position, caused by a change in income, tastes, the number of consumers or the price of a related good.

Q3. In a market, the demand function is Qd = 200 − P and the supply function is Qs = 120 + P, where P is price in dollars per unit. Calculate the equilibrium price and the equilibrium quantity, showing your working. [4 marks]

1. At equilibrium, Qd = Qs, so 200 − P = 120 + P.
2. Rearranging: 200 − 120 = P + P, so 80 = 2P.
3. Solving: P = $40, which is the equilibrium price.
4. Substituting back into either function: Qd = 200 − 40 = 160, or Qs = 120 + 40 = 160, so the equilibrium quantity is 160 units.

Q4. Explain two causes of a rightward shift of the market supply curve. [4 marks]

1. A fall in the price of an input used in production lowers firms' cost of production, so firms are willing to supply more of the good at every price, shifting supply rightward.
2. This happens because lower costs make a given level of output more profitable to produce and sell.
3. Technological progress allows firms to produce more output from the same inputs, which also lowers the cost of production.
4. Firms respond to lower costs by being willing to supply a greater quantity at every price, which shifts the supply curve to the right.

Q5. Using a demand and supply diagram, explain the consequences for equilibrium price and quantity of an increase in consumers' income, assuming the good is a normal good. [6 marks]

1. For a normal good, a rise in consumers' income increases the demand for the good at every price, because consumers can and wish to buy more of it.
2. This is shown on a diagram as a rightward shift of the demand curve from its original position to a new position further to the right, while the supply curve is unchanged.
3. At the original equilibrium price, there is now excess demand, because the quantity that consumers wish to buy at that price has risen while the quantity firms wish to supply has not changed.
4. This excess demand creates an incentive for sellers to raise price, since some buyers are willing to pay more rather than go without the good.
5. As price rises, quantity supplied rises along the unchanged supply curve, and quantity demanded falls back along the new demand curve, until the two are equal again.
6. The new equilibrium is reached at a higher price and a higher quantity than before the income rise, so both equilibrium price and equilibrium quantity increase.

Q6. Explain why the direction of change in equilibrium price cannot always be predicted when both demand and supply shift rightward at the same time. [6 marks]

1. A rightward shift in demand alone would raise both equilibrium price and equilibrium quantity, while a rightward shift in supply alone would lower equilibrium price and raise equilibrium quantity.
2. When both curves shift rightward together, their effects on price pull in opposite directions: the demand shift tends to raise price, while the supply shift tends to lower it.
3. Their effects on quantity pull in the same direction: both shifts tend to raise equilibrium quantity, so the rise in equilibrium quantity is certain.
4. Whether price ends up higher, lower or unchanged depends on which of the two opposing effects is larger, which in turn depends on the relative size of the demand shift compared with the size of the supply shift.
5. If the demand shift is larger than the supply shift, price tends to rise; if the supply shift is larger, price tends to fall; if the two are of equal size, price may stay unchanged.
6. Because the exact size of each shift is not known in advance from the direction alone, the change in equilibrium price cannot be predicted with certainty, only the increase in equilibrium quantity can.

Key takeaways

• Market equilibrium occurs where the demand curve and supply curve intersect, so that quantity demanded equals quantity supplied and there is no tendency for price to change.
• Excess demand pushes price up, and excess supply pushes price down, moving the market towards equilibrium.
• A movement along a demand or supply curve is caused only by a change in the good's own price; a shift of the curve is caused by a change in some other factor.
• Demand shifts when income, the number of consumers, tastes or the price of a related good changes.
• Supply shifts when input prices, technology or the number of firms changes.
• With supply unchanged, a rightward (leftward) shift in demand raises (lowers) both equilibrium price and equilibrium quantity.
• With demand unchanged, a rightward (leftward) shift in supply lowers (raises) equilibrium price while raising (lowering) equilibrium quantity.
• When demand and supply shift in the same direction, the change in equilibrium quantity is certain, but the change in price depends on the relative size of the shifts.
• When demand and supply shift in opposite directions, the change in equilibrium price is certain, but the change in quantity depends on the relative size of the shifts.

Test yourself

What condition must hold for a market to be in equilibrium?

Quantity demanded must equal quantity supplied at the prevailing price, so that the market clears with no excess demand or excess supply.

If price is above equilibrium, is there excess demand or excess supply?

Excess supply, because at a price above equilibrium, firms wish to sell more than consumers wish to buy.

Does a change in a good's own price shift its demand curve?

No. A change in the good's own price causes a movement along the existing demand curve, not a shift of the curve.

How does demand for an inferior good change as income rises?

Demand for an inferior good falls as consumers' income rises, because consumers switch away from it towards other goods.

What happens to equilibrium price and quantity if supply shifts rightward while demand is unchanged?

Equilibrium price falls and equilibrium quantity rises, because the extra supply creates excess supply at the old price, pushing price down.

When demand and supply both shift leftward, what can be said about equilibrium quantity?

Equilibrium quantity decreases with certainty, since both shifts reduce quantity, though the effect on price may go either way.

What two things does a rise in the price of an input used in production do to a firm's supply curve?

It raises the firm's cost of production and shifts its supply curve leftward, so less is supplied at every price.