Use of demand and supply diagrams to illustrate the impact of changes in market conditions

Published by Patrick Mutisya · 14 days ago

IGCSE Economics 0455 – Allocation of Resources: Price Changes

Allocation of Resources – Price Changes

Understanding how market conditions affect price and quantity is essential for analysing resource allocation. This note explains how to use demand and supply diagrams to illustrate these impacts.

1. Basic Demand and Supply Model

The market for a good is represented by two curves:

  • Demand curve: \$Q_d = f(P)\$ – quantity demanded falls as price rises.

  • Supply curve: \$Q_s = g(P)\$ – quantity supplied rises as price rises.

Equilibrium occurs where \$Qd = Qs\$, giving equilibrium price \$P^*\$ and quantity \$Q^*\$.

Suggested diagram: Standard demand and supply curves intersecting at equilibrium (label axes, \$P\$, \$Q\$, \$D\$, \$S\$, \$P^*\$, \$Q^*\$).

2. Shifts in Demand

A change in any factor other than price (e.g., income, tastes, price of related goods) shifts the demand curve.

FactorDirection of Demand ShiftEffect on \$P^*\$Effect on \$Q^*\$
Increase in consumer income (normal good)RightwardRiseRise
Decrease in consumer income (normal good)LeftwardFallFall
Price increase of a substituteRightwardRiseRise
Price increase of a complementLeftwardFallFall

Suggested diagram: Demand curve shifts rightward from \$D1\$ to \$D2\$, new equilibrium at higher \$P^*\$ and \$Q^*\$.

3. Shifts in Supply

Changes in production costs, technology, or the number of sellers shift the supply curve.

FactorDirection of Supply ShiftEffect on \$P^*\$Effect on \$Q^*\$
Improvement in technologyRightwardFallRise
Increase in input pricesLeftwardRiseFall
More firms enter the marketRightwardFallRise
Regulatory restrictionsLeftwardRiseFall

Suggested diagram: Supply curve shifts leftward from \$S1\$ to \$S2\$, new equilibrium at higher \$P^*\$ and lower \$Q^*\$.

4. Simultaneous Shifts in Demand and Supply

When both curves shift, the direction of change in price and quantity depends on the relative magnitude of the shifts.

  1. Both shift rightward: Quantity definitely rises; price may rise, fall, or stay the same.

  2. Both shift leftward: Quantity definitely falls; price outcome is ambiguous.

  3. Demand rightward, supply leftward: Price rises; quantity effect is uncertain.

  4. Demand leftward, supply rightward: Price falls; quantity effect is uncertain.

Suggested diagram: Demand shifts rightward while supply shifts leftward; show new equilibrium with higher price and ambiguous quantity.

5. Government Interventions

Interventions alter the market equilibrium by shifting curves or creating price controls.

5.1 Price Floors (Minimum Prices)

A price floor set above the equilibrium price creates a surplus.

Suggested diagram: Horizontal line above \$P^*\$ representing floor; surplus shown as the distance between \$Qs\$ and \$Qd\$ at that price.

5.2 Price Ceilings (Maximum Prices)

A price ceiling set below the equilibrium price creates a shortage.

Suggested diagram: Horizontal line below \$P^*\$ representing ceiling; shortage shown as the distance between \$Qd\$ and \$Qs\$ at that price.

5.3 Taxes

A specific tax on producers shifts the supply curve upward (or leftward) by the amount of the tax.

Result: higher price to consumers, lower price received by producers, and a reduced quantity.

Suggested diagram: Original supply \$S\$, tax‑shifted supply \$S{tax}\$; show price paid by consumers \$Pc\$, price received by producers \$P_p\$, and tax amount \$t\$.

5.4 Subsidies

A subsidy to producers shifts the supply curve downward (or rightward) by the subsidy amount.

Result: lower price to consumers, higher price received by producers, and an increased quantity.

Suggested diagram: Original supply \$S\$, subsidised supply \$S{sub}\$; indicate consumer price \$Pc\$, producer price \$P_p\$, and subsidy \$s\$.

6. Summary of Price Change Effects

Change in Market ConditionDirection of Curve ShiftResulting Change in \$P^*\$Resulting Change in \$Q^*\$
Increase in consumer income (normal good)Demand rightward↑↑
Improvement in technologySupply rightward↓↑
Price floor above equilibriumArtificial price ↑↑ (set)↓ (effective quantity)
Specific tax on producersSupply leftward by \$t\$↑ (consumer price)↓
Simultaneous demand ↑ and supply ↑ (demand larger)Both rightward↑↑

7. Practice Questions

  1. Explain how a rise in the price of beef (a complement to potatoes) would affect the potato market. Use a diagram to support your answer.

  2. A government introduces a $2 per unit tax on cigarettes. Show the effect on the supply curve and explain the impact on consumer price, producer price, and quantity sold.

  3. Discuss the likely outcomes if a price ceiling is set below the equilibrium price in the rental housing market.

These notes provide the framework for drawing and interpreting demand‑supply diagrams to analyse how changes in market conditions affect price and quantity, thereby illustrating the allocation of resources.