1.2 Demand, supply and market equilibrium: the determinants of demand and supply, movements versus shifts, equilibrium and disequilibrium, and consumer and producer surplus.

What this dot point is asking

OCR wants you to explain what determines demand and supply, to distinguish a movement along a curve (caused by a price change) from a shift of the whole curve (caused by a non-price determinant), to find and interpret market equilibrium, and to identify consumer and producer surplus.

Demand

Demand slopes down for two reasons. The income effect: a lower price raises real income, so consumers can buy more. The substitution effect: a lower price makes the good cheaper relative to substitutes, so consumers switch toward it. Diminishing marginal utility reinforces this: each extra unit gives less satisfaction, so consumers will only buy more at a lower price.

The non-price determinants of demand shift the whole curve: real income, the prices of substitutes and complements, tastes and fashion, population and demographics, advertising, and expectations of future prices. A change in any of these shifts demand left or right; a change in the good's own price is a movement along the curve.

Supply

The non-price determinants of supply shift the curve: costs of production (wages, raw materials, energy), technology and productivity, indirect taxes and subsidies, the number of firms in the market, and the prices of other goods the firm could produce. Lower costs or a subsidy shift supply right; a tax or a cost rise shifts it left.

Movements versus shifts

Market equilibrium

The market clears at the equilibrium price, where quantity demanded equals quantity supplied. There is no tendency to change because every buyer willing to pay the price finds a seller and vice versa. Away from equilibrium the market is in disequilibrium:

• Above equilibrium price, quantity supplied exceeds quantity demanded, creating a surplus (excess supply) that pushes price down.
• Below equilibrium price, quantity demanded exceeds quantity supplied, creating a shortage (excess demand) that pushes price up.

These pressures are the rationing, signalling and incentive functions of the price mechanism at work, returning the market to equilibrium.

Consumer and producer surplus

Together, consumer plus producer surplus measures the total welfare a market generates. Allocative efficiency at the competitive equilibrium maximises this combined surplus. Surplus is also a useful evaluation tool: a tax or a price control changes the size and split of consumer and producer surplus and can create a deadweight loss.

Examples in context

• Energy prices. The 2022 surge in wholesale gas prices was a leftward supply shift (higher input costs) that raised equilibrium prices sharply, with demand relatively price-inelastic in the short run.
• Housing. Restrictive planning keeps housing supply inelastic, so rising demand from population growth feeds mainly into higher prices rather than more homes.
• Streaming subscriptions. New entrants shifting supply right and changing tastes shifting demand have reshaped equilibrium prices in video and music streaming.

Try this

Q1. Distinguish between a movement along and a shift of the demand curve. [4 marks]

• Cue. Movement caused by the good's own price; shift caused by a non-price determinant such as income or tastes.

Q2. Explain what is meant by consumer surplus. [3 marks]

• Cue. Gap between maximum willingness to pay and price actually paid; area under demand and above price.