1-2-3-markets

The interaction of supply and demand

• In a market, prices for goods/services are determined by the interaction of demand and supply 

• A market is any place that brings buyers and sellers together to trade at an agreed price

  • Markets can be physical (e.g. McDonald’s) or virtual (e.g. eBay)

  • Buyers agree on the price by purchasing the good/service

  • If they do not agree on the price, then they do not purchase the good/service

• Based on this interaction with buyers, sellers will gradually adjust their prices until there is an equilibrium price and quantity that works for both parties

  • At the equilibrium price, sellers will be satisfied with the rate/quantity of sales

  • At the equilibrium price, buyers are satisfied that the product provides benefits worth paying for

Equilibrium

Diagram analysis

• If the price is set at £20, demand will equal supply, and an equilibrium is reached

  • 600 units will be demanded and supplied

  • If the price were set above the equilibrium, supply would be greater than demand, and there would be a surplus

  • If the price were set below the equilibrium, demand would be greater than supply, and there would be a shortage

Dynamic changes in markets

• There are four diagrams that can be used to show the causes and consequences of changes to the non-price factors of demand and supply 

The impact of changes to the non-price factors of demand and supply

A rise in demand

Explanation

• The original equilibrium was at P₁ and Q₁

• A rise in demand causes the demand curve to shift to the right from D₁→ D₂ (perhaps due to an increase in working from home)

• At the original price of P1, there is now a shortage, as demand exceeds the supply

• The shortage causes prices to rise from P₁ to P₂

• A new equilibrium develops at a price of P₂ and a quantity of Q₂ units

• The business revenue (P × Q) has changed from P₁Q₁ to P₂Q₂

A fall in demand

Explanation

• The original equilibrium was at P₁ and Q₁

• A fall in demand causes the demand curve to shift to the left from D₁→D₂ (perhaps due to an external shock)

• At the original price of P1, there is now a surplus, as supply exceeds demand

• The surplus causes prices to fall from P₁ to P₂

• A new equilibrium develops at a price of P₂ and a quantity of Q₂ units

• The business revenue (P × Q) has changed from P₁Q₁ to P₂Q₂

A rise in supply

Explanation

• The original equilibrium was at P₁ and Q₁

• A rise in supply causes the supply curve to shift to the right from S₁→S₂ (perhaps due to an increase in productivity)

• At the original price of P₁, there is now a surplus, as supply exceeds demand

• The surplus causes prices to fall from P₁ to P₂

• A new equilibrium develops at a price of P₂ and a quantity of Q₂ units

• The business revenue (P × Q) has changed from P₁Q₁ to P₂Q₂

A fall in supply