Demand and Supply Analysis
In one line. Demand and supply analysis sets the equilibrium price and quantity where the two curves cross. A change in the good's own price moves along a curve, while a non-price determinant shifts the whole curve, creating a shortage or surplus that drives the price to a new equilibrium; elasticity governs the size of the move.
Exam relevance: a core A Level Economics topic, on ETG analysis of the last ten years. Taught the way an economics tutor who wrote the answer keys teaches it.
01The law of demand and supply
Demand and supply analysis is the core toolkit of the whole micro paper: almost every market question is answered by shifting the right curve and tracing what happens to price and quantity.
The law of demand states that, other things equal, a higher price reduces the quantity demanded, so the demand curve slopes downward. The law of supply states that a higher price raises the quantity supplied, so the supply curve slopes upward.
The two curves sit in the same price against quantity space. Demand reflects the marginal benefit buyers place on each unit, falling as more is consumed; supply reflects the marginal cost of producing each unit, rising as output expands. Where they meet sets the price and quantity at which the market settles.
02Market equilibrium
The market is in equilibrium where the quantity demanded equals the quantity supplied, so there is neither a shortage nor a surplus pushing the price to change.
At the equilibrium price Pe and quantity Qe the plans of buyers and sellers are exactly consistent: every unit offered for sale finds a buyer, and every buyer willing to pay the price is served. This clearing point is the reference for everything that follows. A shortage or a surplus is defined against it, surplus and welfare areas are measured from it, and a price control is judged by how far it sits from it.
03What shifts demand
A change in any factor other than the good's own price shifts the whole demand curve, and a complete answer names the specific determinant rather than a vague "demand went up".
- Income. For a normal good, higher income shifts demand right; for an inferior good it shifts demand left.
- Prices of related goods. A rise in the price of a substitute shifts demand right; a rise in the price of a complement shifts it left.
- Tastes and preferences. A shift toward a good, through branding or a structural change such as plant based diets, shifts demand right.
- Expectations. If buyers expect higher prices later, current demand shifts right.
- Number of buyers. A larger market, through population or new buyers, shifts demand right.
Name the exact determinant and say which way the curve moves. "Cheaper energy" does not score; "a fall in the price of gas, a substitute for coal, shifts the demand for coal left" does.
04What shifts supply
The same logic applies on the supply side: anything other than the good's own price that changes the willingness or ability of firms to produce shifts the whole supply curve.
- Input and factor costs. Higher wages, rents or raw material prices shift supply left.
- Technology. An improvement lowers unit costs and shifts supply right.
- Number of sellers. More firms in the market shift supply right; firms leaving shift it left.
- Supply shocks. A drought, an idled fishing fleet or a disrupted harvest shifts supply left.
- Indirect taxes and subsidies. A tax shifts supply left, a subsidy shifts it right.
- Expectations. If firms expect higher prices, they may withhold current supply, shifting it left.
Want this on paper? Grab the free 112 page Summary and Diagrams pack.
05Shift versus movement
This is the pitfall that loses the most marks in the topic, so it is worth stating with care.
A change in the good's own price causes a movement along the curve, a change in quantity demanded or quantity supplied.
A change in a non-price determinant causes a shift of the whole curve, a change in demand or supply.
So a fall in the price of coffee moves us along the coffee demand curve to a larger quantity demanded; a fall in the price of tea, a substitute, shifts the coffee demand curve left. Saying "the lower price raised demand" blurs the two and is marked down.
When two curves move at once, shift both. A frequent error is to shift only one curve when the scenario, such as a labour market with rising demand and a falling supply, changes both.
06How a shift moves the market
A shift does not jump the price to a new level by assertion: it creates a shortage or a surplus at the old price, and that disequilibrium is what drives the price to its new equilibrium.
Suppose a rise in income shifts demand right. At the old price the quantity demanded now exceeds the quantity supplied, so there is a shortage. Buyers compete for the limited goods, bidding the price up. As the price rises, quantity demanded falls back and quantity supplied rises, until the gap is closed at a new, higher equilibrium price and quantity. A leftward supply shift works the same way: the shortage at the old price bids the price up. A rightward supply shift or a leftward demand shift instead creates a surplus that pushes the price down. Always trace the shortage or surplus; the price move is the consequence, not the starting point.
07Elasticity sizes the move
Which curve shifts decides the direction of the price and quantity change; how elastic the other curve is decides the size of it.
When demand rises against a price inelastic supply, supply responds little to the higher price, so the rise lands mostly on price and only a little on quantity. This is exactly why a demand surge in the Singapore property market, where supply is inelastic in the short run, raises prices sharply. The mirror case holds for inelastic demand. Reading the elasticity of the unshifted curve is what turns a correct direction into a correctly sized effect, and it is the link to the elasticities theme.
08Test yourself
- Using a diagram, explain how a fall in the price of a substitute changes the equilibrium price and quantity of a good.
- Classify each as a shift or a movement: a rise in the good's own price, a fall in input costs, an improvement in technology, an increase in consumer income.
- Explain why a rise in demand raises price more than quantity when supply is price inelastic.
09Questions students ask
A movement along the demand curve is caused only by a change in the good's own price, and is called a change in quantity demanded. A shift of the whole demand curve is caused by a non-price determinant such as income, the price of a related good, tastes, expectations or the number of buyers, and is called a change in demand. Confusing the two is the single most common error in this topic.
Demand shifts with income, the prices of related goods (substitutes and complements), tastes and preferences, expectations and the number of buyers. Supply shifts with input or factor costs, technology, the number of sellers, supply shocks such as weather, indirect taxes and subsidies, and producer expectations. Each one shifts the whole curve rather than moving along it.
A shift creates a shortage or surplus at the old price. If demand rises, quantity demanded exceeds quantity supplied at the old price, so the shortage bids the price up to a new equilibrium where the market clears again. If supply falls, the resulting shortage does the same. The size of the price and quantity change depends on how elastic the other curve is.