Definitions of demand and supply

Demand and supply form the foundation of how markets operate, determining the prices and quantities of goods and services available.

Effective demand

Effective demand refers to the amount of a good or service that buyers both want and can afford to purchase at a specific price during a particular period.

Supply

Supply describes the amount of a good or service that producers are prepared and capable of offering to the market at a specific price during a particular period.

Producers seek to maximise profits, so they tend to increase output when higher prices cover rising costs and provide greater returns.

Supply and demand diagrams and equilibrium

Supply and demand diagrams illustrate how prices and quantities interact in a market, helping to identify the point where the market balances.

Key features of supply and demand diagrams

These diagrams plot price (P) on the vertical axis and quantity (Q) on the horizontal axis, featuring two main curves:

• Demand curve (D) - Typically slopes downwards from left to right, indicating that as price rises, the quantity demanded falls.
• Supply curve (S) - Usually slopes upwards from left to right, showing that as price rises, the quantity supplied increases.

Firms will expand production only if the price increase exceeds any additional costs involved.

Equilibrium in the market

Equilibrium occurs where the demand curve and supply curve intersect, known as the market clearing point.

Key terms relating to equilibrium:

• Equilibrium price (Pe) - The price at which the quantity demanded equals the quantity supplied.
• Equilibrium quantity (Qe) - The amount bought and sold at the equilibrium price.

Market imbalances

• Surplus (excess supply) - Happens when price is above equilibrium, leading to more supplied than demanded. This causes a leftward movement along the demand curve and rightward along the supply curve.
• Shortage (excess demand) - Occurs when price is below equilibrium, resulting in more demanded than supplied. This causes a rightward movement along the demand curve and leftward along the supply curve.

Factors affecting demand and supply

Various influences can change the level of demand or supply in a market, beyond just price changes. These factors often relate to consumer behaviour, production conditions, or external events.

Factors that influence demand

• Substitutes - A sharp rise in the price of electric scooters could boost demand for bicycles as an alternative.
• Complementary products - An increase in smartphone prices might reduce demand for related items like protective cases.
• Consumer income - Rising incomes tend to increase demand for premium items, while falling incomes boost demand for cheaper options.
• Fashion and consumer preferences - Growing interest in healthy living can lower demand for processed snacks and raise it for natural foods.
• Advertising and branding - Effective campaigns create loyalty, helping to sustain demand even against rivals.
• Demographics - An older population can heighten demand for medical supplies.
• Seasonal changes - Colder months increase demand for warm clothing, while hotter periods raise demand for fans.
• External shocks - Events like storms can spike demand for essential items such as torches.

Factors that influence supply

• Costs of production - Higher prices for inputs like metals can decrease the supply of manufactured products.
• Indirect taxes - Increased taxes on goods raise effective costs, leading to reduced supply.
• Subsidies - Government grants lower costs, encouraging more output.
• New technology - Advances that improve efficiency can cut costs and expand supply.
• Weather conditions - Poor weather can limit crop yields in farming.
• External shocks - Situations like wars may shift resources away from everyday goods, reducing their supply.

Movements along and shifts in curves

Understanding the difference between movements and shifts is essential for analysing market changes. Movements occur due to price variations, while shifts result from other influences.

Movements along curves

Changes in price lead to movements along the existing demand or supply curve:

• For demand, a price rise moves left along the curve (lower quantity demanded); a price fall moves right (higher quantity demanded).
• For supply, a price rise moves right along the curve (higher quantity supplied); a price fall moves left (lower quantity supplied).

Shifts in curves

Non-price factors cause the entire curve to shift:

• A rightward shift increases demand or supply at every price.
• A leftward shift decreases demand or supply at every price.

Impacts of changes in demand and supply

Shifts in demand or supply curves disrupt the existing equilibrium, leading to new market balances with adjusted prices and quantities.

Effects of demand changes

• Increase in demand - The demand curve shifts right, creating a shortage at the original price. This results in a higher equilibrium price and greater equilibrium quantity.
• Decrease in demand - The demand curve shifts left, causing a surplus at the original price. This leads to a lower equilibrium price and reduced equilibrium quantity.

Effects of supply changes

• Increase in supply - The supply curve shifts right, generating a surplus at the original price. This produces a lower equilibrium price but increased equilibrium quantity.
• Decrease in supply - The supply curve shifts left, creating a shortage at the original price. This causes a higher equilibrium price but lower equilibrium quantity.