How price changes are caused by changes in demand and supply

Published by Patrick Mutisya · 14 days ago

IGCSE Economics – Allocation of Resources: Price Changes

Allocation of Resources – Price Changes

Learning Objective

Explain how changes in demand and supply cause movements in market price.

Key Concepts

  • Demand curve

  • Supply curve

  • Equilibrium price and quantity

  • Shift vs. movement along a curve

1. When Demand Changes

A change in demand means the whole demand curve shifts.

Change in DemandEffect on Equilibrium PriceEffect on Equilibrium Quantity
Increase in demand (right‑hand shift)Price risesQuantity rises
Decrease in demand (left‑hand shift)Price fallsQuantity falls

Reason: At the original price, the quantity demanded exceeds quantity supplied (or vice‑versa), creating a shortage or surplus that pushes the price up or down until a new equilibrium is reached.

2. When Supply Changes

A change in supply shifts the entire supply curve.

Change in SupplyEffect on Equilibrium PriceEffect on Equilibrium Quantity
Increase in supply (right‑hand shift)Price fallsQuantity rises
Decrease in supply (left‑hand shift)Price risesQuantity falls

Reason: At the original price, the quantity supplied exceeds quantity demanded (or vice‑versa), creating a surplus or shortage that moves the price in the opposite direction.

3. Simultaneous Shifts in Demand and Supply

  1. If both curves shift in the same direction, the effect on price is ambiguous, but quantity moves in the direction of the shifts.

  2. If they shift in opposite directions, the effect on price depends on the relative magnitude of the shifts.

Example: An increase in demand together with an increase in supply may leave price unchanged if the shifts are equal, while quantity definitely rises.

4. Mathematical Representation

Market equilibrium is where \$QD = QS\$.

Suppose demand is \$QD = a - bP\$ and supply is \$QS = c + dP\$, where \$a,b,c,d>0\$.

\$P^* = \frac{a - c}{b + d}, \qquad Q^* = \frac{ad + bc}{b + d}\$

A right‑hand shift in demand increases \$a\$; a right‑hand shift in supply increases \$c\$. Substituting a larger \$a\$ raises \$P^*\$, while a larger \$c\$ lowers \$P^*\$.

5. Real‑World Examples

  • Demand increase: A new health study shows that coffee improves concentration, leading to higher demand and higher coffee prices.

  • Supply decrease: A frost destroys a large portion of wheat crops, reducing supply and raising wheat prices.

Suggested diagram: Demand and supply curves showing a right‑hand shift in demand and the resulting higher equilibrium price.

Summary Checklist

  • Identify whether a change is a shift of the curve or a movement along the curve.

  • State the direction of the shift (right or left).

  • Predict the direction of change in equilibrium price and quantity.

  • Explain the underlying reason (shortage or surplus).