Diagrams that illustrate shifts of a supply curve

Cambridge IGCSE Economics (0455) – Supply‑Side and Market Concepts

1. The Basic Economic Problem

Scarcity – limited resources, unlimited wants. Societies must decide how to allocate resources efficiently.

• Factors of production:
  • Land (natural resources) – reward: rent
  • Labour – reward: wages
  • Capital (machinery, equipment) – reward: interest
  • Enterprise (entrepreneurship) – reward: profit
• Opportunity cost – the next best alternative foregone when a choice is made.

1.1 Production Possibility Curve (PPC)

2. Allocation of Resources – Demand and Price Determination

2.1 Demand

Demand is the amount of a good or service that households are willing and able to buy at each price during a given period.

• Demand curve: price (P) on the vertical axis, quantity demanded (Q_d) on the horizontal axis.
• Downward‑sloping because a lower price increases the quantity demanded (law of demand).

2.2 Determinants of Demand (shift the demand curve)

Determinant	Shift Direction	Reason
Income (normal good)	↑ income → right shift ↓ income → left shift	Higher income raises purchasing power.
Income (inferior good)	↑ income → left shift ↓ income → right shift	Consumers switch to higher‑quality alternatives.
Prices of related goods	Substitutes ↑ → right shift Complements ↑ → left shift	Changes in relative prices alter consumption patterns.
Consumer preferences	More favourable → right shift Less favourable → left shift	Trends, advertising, health information, etc.
Expectations of future prices	Expect rise → right shift (buy now) Expect fall → left shift (delay purchase)	Consumers try to maximise utility.
Number of buyers	More buyers → right shift Fewer buyers → left shift	Population growth or demographic change.

2.3 Diagram – Right shift of demand (increase in consumer income)

2.4 Price Elasticity of Demand (PED)

• Definition: % change in quantity demanded resulting from a 1 % change in price.
• Formula: PED = (%ΔQ_d)/(%ΔP)
• Interpretation
  • PED > 1 – demand is **elastic** (large response to price change).
  • PED = 1 – demand is **unit‑elastic**.
  • PED < 1 – demand is **inelastic** (small response).

2.5 Determinants of PED

• Availability of close substitutes – more substitutes → more elastic.
• Proportion of income spent on the good – larger share → more elastic.
• Definition of the market – narrowly defined markets → more elastic.
• Time horizon – demand becomes more elastic in the long run.

2.6 Diagram – Elastic vs. Inelastic Demand

3. Supply and Shifts of the Supply Curve

3.1 Supply

Supply is the amount of a good or service that firms are willing and able to sell at each price during a given period.

• Supply curve: price (P) on the vertical axis, quantity supplied (Q_s) on the horizontal axis.
• Usually upward‑sloping because higher prices increase the incentive to produce.

3.2 Determinants of Supply (shift the supply curve)

Determinant	Shift Direction	Reason
Input (resource) prices	↓ input price → right shift ↑ input price → left shift	Lower costs make production cheaper.
Technology	Improvement → right shift Technological decline → left shift	More efficient techniques increase output for the same cost.
Number of sellers	More firms → right shift Fewer firms → left shift	Total market supply rises or falls.
Expectations of future prices	Expect higher future price → left shift (hold back stock) Expect lower future price → right shift (sell now)	Firms adjust current output to maximise future profit.
Taxes and subsidies	Tax on production → left shift Subsidy → right shift	Taxes raise marginal cost; subsidies lower it.
Natural conditions	Favourable weather/conditions → right shift Adverse weather/conditions → left shift	Physical environment affects ability to produce.
Government regulation	More restrictive regulation → left shift Deregulation → right shift	Regulations can increase compliance costs or remove barriers.

3.3 Diagram – Right shift of supply (fall in input costs)

3.4 Diagram – Left shift of supply (per‑unit tax)

4. Price Elasticity of Supply (PES)

• Definition: % change in quantity supplied resulting from a 1 % change in price.
• Formula: PES = (%ΔQ_s)/(%ΔP)
• Interpretation
  • PES > 1 – supply is **elastic**.
  • PES = 1 – supply is **unit‑elastic**.
  • PES < 1 – supply is **inelastic**.

4.1 Determinants of PES

• Time period – supply is more elastic in the long run.
• Availability of inputs – abundant inputs → more elastic.
• Flexibility of production methods – adaptable technology raises elasticity.
• Mobility of factors of production – easy movement of labour/equipment increases elasticity.

4.2 Diagram – Elastic vs. Inelastic Supply

5. Market and Mixed Economic Systems

5.1 Market (Free‑Market) Economy

Decisions about what, how and for whom to produce are made by private households and firms interacting through markets.

Advantages	Disadvantages
Efficient allocation of resources via the price mechanism. Consumer sovereignty – choices driven by demand. Incentives for innovation and entrepreneurship.	Market failures (externalities, public goods, information asymmetry). Potential for income inequality. Undersupply of merit goods.

5.2 Mixed Economy (required by the syllabus)

A mixed economy combines market mechanisms with government intervention to correct market failures and achieve equity goals.

5.2.1 Government tools (supply‑side focus)

Tool	Effect on Supply Curve	Typical Objective
Tax on production (or per‑unit tax)	Shift left (decrease supply)	Reduce output of a demerit good, raise revenue, internalise negative externalities.
Subsidy to producers	Shift right (increase supply)	Encourage supply of a merit good, support a strategic industry.
Regulation / licensing (e.g., emission limits, safety standards)	Usually shift left (higher compliance cost)	Correct negative externalities, protect health and safety.
Direct provision of goods and services	Not a curve shift – the government becomes an additional supplier.	Provide merit goods (education, healthcare) that the market would under‑supply.
Price ceiling (maximum price)	Creates a shortage if set below equilibrium – not a supply shift.	Make essential goods affordable.
Price floor (minimum price)	Creates a surplus if set above equilibrium – not a supply shift.	Support producers (e.g., agricultural price supports).

5.3 Evaluation of Supply‑Side Policies (AO3)

• State the policy’s explicit objective (e.g., reduce smoking, increase renewable energy).
• Explain the direct impact on the supply curve using the appropriate diagram.
• Analyse short‑run effects (price, quantity, government revenue) and long‑run effects (changes in PES, market structure).
• Consider possible unintended consequences: black‑market activity, administrative costs, impact on related markets, time lags.
• Weigh advantages against disadvantages before drawing a balanced conclusion.

6. Market Failure and Government Intervention

When the free market does not allocate resources efficiently, a market failure occurs.

• Public goods – non‑rival & non‑excludable (e.g., street lighting). Markets under‑supply them → government provision.
• Merit goods – socially desirable but under‑consumed (e.g., education, vaccinations). Government may subsidise or provide directly.
• Demerit goods – socially undesirable but over‑consumed (e.g., tobacco). Government may tax or regulate.
• Externalities
  • Negative – pollution imposes a cost on third parties.
  • Positive – beekeeping benefits nearby fruit growers.
• Monopoly – single seller can restrict output and raise price, leading to allocative inefficiency.

6.1 Supply‑side tools to correct failures (summary)

Failure	Typical Supply‑side tool	Result on supply
Negative externality (pollution)	Tax on production or stricter regulation	Left shift – reduces output, internalises cost.
Positive externality (research spill‑over)	Subsidy to producers	Right shift – encourages more output.
Under‑supply of merit good	Direct government provision or subsidy	Right shift (or additional supply from public sector).
Demerit good	Excise tax or restrictive regulation	Left shift – curbs consumption.

7. Micro‑Decision‑Makers

The syllabus expects students to understand the three main economic agents.

• Households – decide what to buy and how much labour to supply; aim to maximise utility subject to income.
• Workers (labour market) – supply labour; wages are set by the interaction of labour supply and demand.
• Firms – decide what, how and how much to produce; aim to maximise profit where marginal cost = marginal revenue.

7.1 Links to supply

• Firms’ production decisions generate the market supply curve.
• Changes in input prices (e.g., wages, raw materials) shift the supply curve.
• Technological adoption influences both costs and the price elasticity of supply.

8. Money & Banking (Brief Overview)

• Forms of money: cash (notes & coins), demand deposits, electronic money.
• Functions of money: medium of exchange, unit of account, store of value, standard of deferred payment.
• Central bank (e.g., Bank of England) – controls monetary policy, issues currency, acts as lender of last resort.
• Commercial banks – accept deposits, provide loans, create money through the fractional‑reserve system.

8.1 Diagram – Simple Money‑Creation Process

9. Illustrative Example – Coffee Market (Supply & Demand Interaction)

1. Event: Global price of coffee beans (an input) falls.
2. Supply effect: Lower input cost shifts the supply curve right from S₁ to S₂.
3. Demand side: Assume no change in consumer preferences, so demand remains D.
4. New equilibrium: Intersection moves from (P₁, Q₁) to (P₂, Q₂) where P₂ < P₁ and Q₂ > Q₁.

10. Evaluation Tip (AO3) – Structured Answer Checklist

11. Key Takeaways

• Scarcity forces societies to allocate limited resources; the PPC visualises choice and opportunity cost.
• Demand curves slope downwards; supply curves slope upwards. Shifts are caused by non‑price determinants.
• Price elasticity of demand (PED) and supply (PES) measure responsiveness; both depend on time, substitutes, input availability, and production flexibility.
• Market economies rely on the price mechanism but can suffer from market failures that justify government intervention.
• Mixed economies combine market efficiency with government tools (taxes, subsidies, regulation, direct provision) to achieve equity and correct failures.
• Understanding the roles of households, workers and firms links micro‑decisions to the aggregate supply curve.
• Money, banks and the central bank provide the monetary backdrop that influences overall economic activity.
• Effective exam answers must combine clear diagrams, accurate terminology and balanced evaluation of supply‑side policies.