1.1 Competitive Markets: Demand & Supply
Sub-topic
The nature of markets
DEMAND
The law of Demand
SL/HL Core – Assessment Objectives
AO1 – Outline the meaning of the term market.
A place where buyers and sellers come together to carry out an economic transaction.
AO1 – Define Demand.
The ability and willingness of consumers to buy a quantity of a good or service at a
certain price in a given time period, ceteris paribus.
AO2 – Explain the negative causal relationship between price and quantity
demanded. (Include ceteris paribus)
As the price of a product falls, the quantity demanded of the product will usually
increase, ceteris paribus.
The Demand Curve
AO1 – Describe the relationship between an individual consumer’s demand and
market demand.
Market demand is the sum total of all individual consumers’ demand.
The demand curve represents the relationship between the price and the quantity
demanded of a product, ceteris paribus.
AO4 – Draw a demand curve.
Non-price
determinants of
demand
Movements along and
shifts of the demand
curve.
AO2 – Explain the non-price determinants of demand. T,B,P,I,E. (Include
references to normal vs. inferior goods, substitutes vs. complements, and
demographics.)
The non-price determinants of demand include tastes of consumers (can change due
to seasonal changes or simply new trends), number of buyers (if the demographics of
a population mean there are a large number of old people, there will be a higher
demand for products they use, e.g. walking sticks), prices of substitutes of
complements of the product (if a substitute good has a lower price, demand for the
higher priced product will decrease in most cases, if the price of complements go
down, e.g. DVD players, the demand for the complementary product will go up, e.g.
DVDs), income of consumers (if the income of consumers rises the demand for
normal goods, e.g. foreign holidays, will increase, however inferior goods, e.g.
second hand clothing, will have a decrease in demand) and expectations of
consumers (e.g. if consumers expect the price of a product to rise they may stock up
on it and demand will increase in the short term).
AO2 – Distinguish between movements along the demand curve and shifts of the
demand curve.
A change in price results in a movement along the demand curve. A change in nonprice determinants, a change in demand at every price, results in a shift of the
demand curve.
AO4 – Draw diagrams to show the difference.
Movement along Demand Curve
HL ONLY
Linear Demand
Functions
SUPPLY
The law of Supply
Shift of Demand Curve
Qd = a – bP. Slope = -b. Change in “a” = shift in demand curve. Change in “b”
affects the steepness of the demand curve.
AO4 – Plot a demand curve from the linear function (eg. Qd = 60 – 5P).
AO1 – Define Supply.
The ability and willingness of producers to produce a quantity of a good or service at
a certain price in a given time period, ceteris paribus.
AO2 – Explain the positive causal relationship between price and quantity
supplied. (include ceteris paribus)
As the price of a product rises, the quantity supplied of the product will usually
increase, ceteris paribus.
The Supply curve
Non-price
determinants of supply
AO1 – Describe the relationship between an individual consumer’s demand and
market demand.
Market supply is the sum total of all individual producers’ supply of a particular
good or service.
The supply curve represents the relationship between the price and the quantity
supplied of a product, ceteris paribus.
AO4 – Draw a supply curve.
AO2 – Explain the non-price determinants of supply. RENT TP. (Include
references to 4 factors of production.)
As demonstrated by the PPC Curve, a change in the quantity or quality of the 4
factors of production (land, labor, capital, entrepreneurship) would cause an
increase in the capacity of an economy to produce both Good A and Good B. This
change involves the non-price determinants of supply so that it would also cause a
change in the supply of a product.
Movements along and
shifts of the supply
curve.
The non-price determinants of supply include resources (e.g. a change in the land
aspect of production), expectations (e.g. if producers expect there to be an increase
in demand for a bubble tea, they might supply more of it), number of sellers (e.g. as
the number of sellers of a product rises, the overall market supply also rises), taxes
and subsidies (if a product is subsidized, supply could increase, while if a product is
taxed, supply could decrease), technology (this may mean advancements in the
quality of land and capital) and the price of other products the supplier could make
instead (these might be substitute goods that are selling at a higher price to the once
charged for the good the supplier is currently selling).
AO2 – Distinguish between movements along the supply curve and shifts of the
supply curve.
A change in price results in a movement along the supply curve. A change in nonprice determinants, a change in supply at every price, results in a shift of the supply
curve.
AO4 – Draw diagrams to show the difference
Movement along Supply Curve
HL ONLY
Linear supply function
Shift of Supply Curve
Qs = c + dP. Slope = d. Change in “c” = shift in supply curve. Change in “d”
affects the steepness of the demand curve.
AO4 – Plot a supply curve from the linear function (eg. Qs = –30 + 20P).
MARKET EQUILIBRIUM
Equilibrium and
AO3 – Analyze, using diagrams, how changes in the determinants of demand or
changes to equilibrium supply result in a new market equilibrium (Include references to excess demand
and excess supply)
This diagram shows an increase in the demand curve due to a change in one of the
non-price determinants of demand (e.g. taste). Since the supply of that product has
not changed, however, both equilibrium price and quantity increase.
This diagram shows an increase in the supply curve due to a change in one of the
non-price determinants of supply (e.g. technology). Since the demand of that product
has not changed, however, equilibrium price drops while equilibrium quantity
increases.
At this price, the quantity will fall to Qs and the quantity demanded will rise to Qd,
creating an excess demand of Qd–Qs. More is being demanded than supplied at this
price, which causes upward pressure on the price. To eliminate the shortage,
suppliers will have to raise prices. This will cause the quantity supplied to increase
and the quantity demanded to decrease until equilibrium is reached.
HL ONLY
Calculating and
illustrating equilibrium
using linear equations
At this price, the quantity demanded will fall to Qd and the quantity supplied will rise
to Qs, creating an excess supply of Qs–Qd. More is being supplied than demanded at
this price, which causes downward pressure on the price. To eliminate the surplus,
suppliers will have to lower prices. This will cause quantity demanded to increase
and the quantity supplied to decrease until equilibrium is reached.
AO4 – Calculate the equilibrium price and equilibrium quantity from linear
demand and supply functions.
Equilibrium price is $3.30. Equilibrium quantity is 43.
AO4 – Plot demand and supply functions, and identify the equilibrium price and
quantity.
AO4 – Calculate the quantity of excess demand or excess supply using linear
equations.
No excess demand or supply since no movement along either demand or supply curve.
THE ROLE OF THE PRICE MECHANISM
Resource allocation
AO2 – Explain how price acts as a signal and an incentive to consumers and
producers, which results in a reallocation of resources.
As consumers increase their demand for a good, (shift of demand curve to the right),
the price of the good and profits rise, acting as a “green light” signal to producers to
increase their output (movement along the supply curve).
As the supply of a commodity becomes more scarce, (supply shifts to the left), the rise
in price signals to consumers to reduce their demand (movement along the demand
curve).
An increase in demand for a product will raise its price and profitability and provide
the incentive for producers to supply more/new firms to enter the market.
Higher demand for a product will also lead to an increase in demand for labor to
produce the product, causing wages to rise, which will in turn provide an incentive
for workers to seek employment in that industry.
As a result, resource allocation will also change (see PPC diagram below).
For instance, if the profitability of Good A were to increase, more factors of
production would be invested in the industry of Good A. Since there is a scarcity of
resources, however, this would mean fewer factors of production invested in the
industry of Good B.
MARKET EFFICIENCY
Consumer surplus and Allocative Efficiency: The best allocation of resources from society’s point of view is
Producer surplus
at competitive market equilibrium, where community surplus (consumer surplus plus
producer surplus) is maximized.
AO2 – Explain the concept of consumer surplus.
Consumer surplus is the extra satisfaction (utility) gained by consumers from paying
a price that is lower than that which they are prepared to pay.
AO2 – Explain the concept of producer surplus.
The excess of actual earnings that a producer makes from a given quantity of output,
over and above the amount the producer would be prepared to accept for that output.
AO4 – Identify consumer and producer surplus on a demand and supply
diagram.