effects of shifts in demand and supply curves on equilibrium price and quantity

Cambridge IGCSE/A‑Level Economics 9708 – Interaction of Demand and Supply

Syllabus Map (AS‑Level – Section 2)

Syllabus Code	Topic Covered in These Notes	What Still Needs to Be Added
2.1 – The price mechanism	Demand & supply curves, equilibrium, shifts, price‑mechanism box	Link to resource allocation & PP​C (see Context box)
2.2 – Elasticities of demand and supply	Formulas, worked examples for PED, YED, XED, sign‑convention	None – covered
2.3 – Consumer and producer surplus	Definition, diagram, welfare, effect of shifts & policy	None – covered
2.4 – Interaction of demand and supply	Individual & combined shifts, dominance rule, algebraic example	None – covered
2.5 – Government intervention in markets	Tax, subsidy, price floor/ceiling – curve shifts, incidence, DWL, surplus changes	None – covered
3.1‑3.4 – AD/AS, growth, unemployment, inflation	Bridge paragraph linking demand‑supply analysis to AD/AS	None – covered

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Learning Objective

Analyse how shifts in the demand and supply curves affect the equilibrium price (P*) and equilibrium quantity (Q*) in a competitive market, evaluate the resulting welfare implications, and apply the same analytical framework to government intervention and the AD/AS model.

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Context Box – Why Demand & Supply Matter (The Price Mechanism)

Because resources are scarce, societies must decide how to allocate them. The price mechanism – the interaction of demand and supply – converts consumer preferences and producer costs into market outcomes (prices and quantities). It therefore determines which points on the Production Possibility Curve are actually produced, guiding efficient resource allocation without central planning.

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Key Concepts

• Demand curve (D): Downward‑sloping relationship between price (P) and quantity demanded (Q_D).
• Supply curve (S): Upward‑sloping relationship between price (P) and quantity supplied (Q_S).
• Equilibrium: Intersection of D and S where Q_D=Q_S=Q* and P_D=P_S=P*.
• Shift vs. movement: A shift moves the whole curve (determinant change); a movement occurs along the same curve because of a price change.

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Determinants of a Demand Shift (Syllabus 2.1‑2.4)

Determinant	Effect on Demand Curve
Consumer income (normal vs. inferior goods)	↑ for normal goods, ↓ for inferior goods
Tastes & preferences	↑ if the good becomes more fashionable, ↓ if less fashionable
Prices of related goods	↑ for substitutes when their price rises; ↑ for complements when their price falls
Expectations of future price or income	↑ if consumers expect higher future price or income; ↓ otherwise
Number of buyers (market size)	↑ when the market expands, ↓ when it contracts

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Determinants of a Supply Shift (Syllabus 2.1‑2.4)

Determinant	Effect on Supply Curve
Input prices (wages, raw materials)	↑ input cost → supply left (↓); ↓ input cost → supply right (↑)
Technology	Improvement → supply right (↑); regression → supply left (↓)
Expectations of future price	Expect higher future price → current supply left (↓); expect lower → right (↑)
Number of sellers (market structure)	More sellers → supply right (↑); fewer sellers → left (↓)
Government policies (taxes, subsidies, regulation)	Tax/subsidy → shift left/right depending on incidence; regulation can shift either way

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Elasticities (Syllabus 2.2)

1. Price Elasticity of Demand (PED)

• Formula: ε_P = (%ΔQ_D) / (%ΔP)
• Interpretation:
  • |ε| > 1 – elastic (quantity changes proportionally more than price)
  • |ε| < 1 – inelastic (quantity changes proportionally less than price)
  • |ε| = 1 – unit‑elastic
• Sign convention: the numerator and denominator move in opposite directions, so ε is negative for the law of demand. In exam answers state “PED is negative because price and quantity demanded move in opposite directions.”
• Worked example:
  Price falls from £10 to £8 (‑20 %). Quantity demanded rises from 100 to 140 (+40 %).
  ε_P = (+40 %)/‑20 % = ‑2 → |ε| = 2 (elastic).
  Revenue implication: because demand is elastic, total revenue falls when price falls.

2. Income Elasticity of Demand (YED)

• Formula: ε_Y = (%ΔQ_D) / (%ΔY)
• Positive → normal good; Negative → inferior good.
• Worked example:
  Income rises by 10 % and quantity demanded for smartphones rises from 500 000 to 560 000 (+12 %).
  ε_Y = (+12 %)/(+10 %) = 1.2 → normal good, relatively elastic with respect to income.

3. Cross‑price Elasticity of Demand (XED)

• Formula: ε_XY = (%ΔQ_{D_X}) / (%ΔP_Y)
• Positive → substitutes; Negative → complements.
• Worked example:
  Price of butter rises by 15 % and demand for margarine rises from 200 000 to 230 000 (+15 %).
  ε_XY = (+15 %)/(+15 %) = 1.0 → butter and margarine are substitutes with unit‑elastic cross‑price response.

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Consumer & Producer Surplus (Syllabus 2.3)

• Consumer surplus (CS): Area between the demand curve and the market price, up to the quantity bought. It measures the extra benefit consumers obtain because they are willing to pay more than the price.
• Producer surplus (PS): Area between the supply curve and the market price, up to the quantity sold. It measures the extra benefit producers obtain because they are willing to sell for less than the price.
• Total welfare (economic surplus): CS + PS.
• Effect of a demand shift:
  • Demand ↑ → CS rises (larger area under D) and PS also rises because the higher equilibrium price benefits producers.
  • Demand ↓ → both CS and PS fall.
• Effect of a supply shift:
  • Supply ↑ → CS rises (lower price) while PS may rise or fall depending on the magnitude of the price change; total welfare usually rises.
  • Supply ↓ → CS falls, PS may rise (higher price) but total welfare usually falls.
• Effect of government intervention (see table below): each policy changes CS and PS in a predictable way; the net loss is shown by the dead‑weight loss (DWL) triangle.

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Government Intervention (Syllabus 2.5)

Taxes, subsidies, price floors and price ceilings shift either the supply or demand curve. The analysis must include (i) the direction of the shift, (ii) incidence (who bears the burden), (iii) the new equilibrium, and (iv) the welfare impact (change in CS, PS and DWL).

Policy	Initial Curve Shift	Resulting Change in P* and Q*	Incidence (who bears the burden)	Welfare Impact
Specific tax on producers (per‑unit)	Supply shifts left (↑ marginal cost)	Consumer price ↑, producer net price ↓, Q* ↓	Tax burden split between consumers and producers according to relative elasticities (more elastic side bears less burden).	CS ↓, PS ↓, tax revenue = (Pc‑Pp)·Q*; DWL = triangle between old & new curves.
Specific subsidy to producers (per‑unit)	Supply shifts right (↓ marginal cost)	Consumer price ↓, producer net price ↑, Q* ↑	Benefit shared: consumers enjoy lower price, producers receive higher net price.	CS ↑, PS ↑, government outlay = (Pp‑Pc)·Q*; DWL = triangle between old & new curves (over‑production).
Price floor (minimum price) above equilibrium	Effective price set above P*; creates excess supply.	P* ↑ (floor price), Qsupplied ↑, Qdemanded ↓ → surplus stock.	Producers receive higher price on the units sold; unsold surplus may be bought by government or wasted.	CS ↓ (higher price), PS may rise on sold units but falls on unsold surplus; DWL = triangle between demand curve and floor price.
Price ceiling (maximum price) below equilibrium	Effective price set below P*; creates excess demand.	P* ↓ (ceiling price), Qdemanded ↑, Qsupplied ↓ → shortage.	Consumers who obtain the good pay a lower price; producers receive lower price on the reduced output.	PS ↓, CS may rise for those who obtain the good but falls for those who cannot; DWL = triangle between supply curve and ceiling price.

Calculating Dead‑Weight Loss (DWL): If the vertical distance between the old and new price is ΔP and the horizontal distance between the old and new quantity is ΔQ, the DWL area is ½ × ΔP × ΔQ (a right‑angled triangle).

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Effects of Individual Shifts

Shift	Direction of P*	Direction of Q*	Reasoning
Demand ↑ (right)	↑	↑	Higher willingness to pay at every price pushes the equilibrium price up; suppliers respond by supplying more.
Demand ↓ (left)	↓	↓	Lower willingness to pay pulls the price down and reduces the quantity exchanged.
Supply ↑ (right)	↓	↑	More goods are available at each price, so the market price falls while quantity rises.
Supply ↓ (left)	↑	↓	Fewer goods at each price force the price up and the quantity down.

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Combined Shifts – How to Analyse (Exam Technique)

1. Identify the direction of each shift (↑ or ↓).
2. Judge relative magnitude:
   • If the demand shift dominates, P* moves in the direction of the demand shift.
   • If the supply shift dominates, P* moves in the direction of the supply shift.
   • If both shifts are of equal size, P* may stay unchanged while Q* moves.
3. Sketch the new curves (or use algebra) to locate the new equilibrium.
4. State the welfare outcome – note any change in CS, PS and any DWL.

Algebraic Example (Combined Shift)

Initial market: Q_D = 180 – 1.5P, Q_S = –30 + P.

1. Original equilibrium:
   180 – 1.5P = –30 + P → 2.5P = 210 → P* = £84, Q* = –30 + 84 = 54 units.
2. Simultaneous shifts:
   • Consumer income rises → demand increases by 20 units at every price: Q_D = 200 – 1.5P.
   • Input price rises → supply decreases by 10 units at every price: Q_S = –40 + P.
3. New equilibrium:
   200 – 1.5P = –40 + P → 2.5P = 240 → P* = £96, Q* = –40 + 96 = 56 units.
4. Interpretation: The demand increase (↑) dominates the supply decrease (↓) for price, so P* rises. Quantity rises slightly because the upward shift in demand outweighs the leftward shift in supply.

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Link to AD/AS (Syllabus 3.1‑3.4)

The same analytical framework applies to the macro‑economic aggregate‑demand/aggregate‑supply model.

• A right‑shift in AD is analogous to a right‑shift in a demand curve – it raises the price level (P) and output (Y) if AS is upward‑sloping.
• A right‑shift in AS mirrors a right‑shift in supply – it lowers the price level and raises output.
• Government policies that affect AD (e.g., fiscal stimulus) or AS (e.g., investment in technology) are evaluated by the same steps: identify the shift, determine the new equilibrium, and assess welfare (inflation vs. unemployment trade‑offs).

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Worked Numerical Example (Including Policy)

Initial market: Q_D = 200 – 2P, Q_S = –20 + 3P.

1. Original equilibrium: 200 – 2P = –20 + 3P → 5P = 220 → P* = £44, Q* = 112 units.
2. Simultaneous shifts:
   • Technology improves → supply right by 30 units: Q_S = 10 + 3P.
   • Consumer income rises → demand right by 40 units: Q_D = 240 – 2P.
3. New equilibrium: 240 – 2P = 10 + 3P → 5P = 230 → P* = £46, Q* = 148 units.
4. Welfare change (no policy): Both CS and PS increase because price rises modestly while quantity rises substantially.
5. Introduce a specific tax of £5 per unit on producers:
   • Supply shifts left by £5 in price terms: new supply equation Q_S = 10 + 3(P‑5) → Q_S = –5 + 3P.
   • Re‑equilibrate with the shifted demand (240 – 2P):
     240 – 2P = –5 + 3P → 5P = 245 → P* = £49, Q* = 142 units.
   • Consumer price = £49, producer net price = £44 (after tax). Tax revenue = (£49‑£44) × 142 = £710.
   • CS falls (higher price), PS falls (lower net price), DWL = ½ × (£5) × (148‑142) = £15.

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Quick‑Check Summary

• Identify the determinant → decide whether the curve shifts left or right.
• Use the dominance rule to predict the direction of P* and Q* when both curves shift.
• Calculate PED, YED, XED with the %‑change formulas; remember PED is negative.
• When a policy is introduced, note:
  • Which curve moves?
  • Who bears the incidence (use relative elasticities)?
  • New equilibrium price and quantity.
  • Change in CS, PS and the area of DWL (½ × ΔP × ΔQ).
• Apply the same steps to AD/AS – a shift in AD behaves like a demand shift, a shift in AS like a supply shift.