Demand & Supply

Determinants, shifts vs movements, Law of Demand & Supply — the foundation of every market question on Papers 1 & 3

SPEC 1.2 • HOW MARKETS WORK

The Law of Demand

DEFINITION — DEMAND

Demand is the quantity of a good or service that consumers are willing and able to purchase at a given price, in a given time period.

The Law of Demand states that, ceteris paribus, as price rises, quantity demanded falls — and vice versa. This gives the demand curve its downward slope.

WHY IT SLOPES DOWN — Two Reasons

Substitution effect: as price rises, consumers switch to cheaper substitutes.

Income effect: as price rises, real income falls — consumers can afford less of the good.

Exam Tip

Always include ceteris paribus when stating the law of demand. The examiner expects it. Also remember: the law applies to normal goods — Giffen and Veblen goods are exceptions but are rarely examined at A Level.

The Demand Curve — Diagram

Every question about demand requires a fully labelled diagram. Learn this diagram perfectly.

P falls from P₁ → P₂: quantity demanded rises from Q₁ → Q₂. This is a movement along the demand curve — caused only by a price change.

Shifts vs Movements — The Critical Distinction

Examiner Alert — Most Common Error

Students frequently confuse a movement along the demand curve with a shift of the demand curve. This costs marks on every paper. Know the difference precisely.

Movement Along the CurveShift of the Curve

Caused byA change in the price of the good itselfA change in any other determinant

EffectMove to a different point on the same curveEntire curve shifts left or right

Language"Quantity demanded changes""Demand increases/decreases"

ExamplePrice of coffee rises → Qd of coffee fallsIncome rises → D for coffee shifts right

Exam Tip

In essays and data response, always state which way the curve shifts (right = increase, left = decrease) and state the resulting change in both equilibrium price and quantity.

Demand Shifters — PIYEN

Memorise the five conditions of demand using the mnemonic PIYEN:

Price of related goods

Substitutes & complements

Income

Normal vs inferior goods

Your tastes & preferences

Fashion, advertising, health

Expectations of future price

Buy now before price rises

Number of consumers

Population, demographics

PRICE OF RELATED GOODS — critical detail

Substitutes (e.g. butter & margarine): price of substitute rises → D for the good shifts RIGHT

Complements (e.g. cars & petrol): price of complement rises → D for the good shifts LEFT

Normal goods: income rises → D shifts RIGHT. Inferior goods: income rises → D shifts LEFT

Diagram: Shift in Demand

When a non-price determinant changes, the entire curve shifts. You must draw this clearly and correctly in any diagram-based answer.

Income rises

Consumers can afford more

Demand shifts RIGHT (D₁→D₂)

Higher P* & Q* at equilibrium

The Law of Supply

DEFINITION — SUPPLY

Supply is the quantity of a good or service that producers are willing and able to offer for sale at a given price, in a given time period.

The Law of Supply states that, ceteris paribus, as price rises, quantity supplied rises — and vice versa. This gives the supply curve its upward slope.

WHY IT SLOPES UPWARD

Higher prices mean higher profit margins — existing firms are incentivised to expand output.

Higher prices attract new firms into the market, increasing total supply.

As output rises, marginal costs increase (law of diminishing returns) — firms only supply more at higher prices.

Exam Tip

Just like demand, distinguish between quantity supplied (movement along) and supply (the whole curve). A price change causes the former; everything else causes the latter.

Supply Shifters — PINTSWC

Memorise the conditions of supply using PINTSWC:

LetterFactorEffect if Increases

PProductivity / TechnologyCosts fall → Supply shifts RIGHT

IInput costs (wages, raw materials)Costs rise → Supply shifts LEFT

NNumber of firms in marketMore firms → Supply shifts RIGHT

TTaxes & SubsidiesTax = LEFT; Subsidy = RIGHT

SSeasons & weatherBad harvest → Supply shifts LEFT

WWorld / commodity pricesOil price rise → LEFT (cost-push)

CChanges in regulationStricter rules → Costs rise → LEFT

Diagram: Supply Curve & Shift

Technology improves

Production costs fall

Supply shifts RIGHT (S₁→S₂)

Lower P* & Higher Q*

Diminishing Marginal Utility

DEFINITION

Marginal utility is the additional satisfaction gained from consuming one more unit of a good. The law of diminishing marginal utility states that, ceteris paribus, as consumption of a good increases, the marginal utility derived from each additional unit eventually falls.

LINK TO DEMAND CURVE SHAPE

Because marginal utility falls as quantity rises, consumers are only willing to pay a lower price for additional units. This explains why the demand curve slopes downward.

Example: The first cup of coffee gives you high utility — you'd pay £3. The second gives less utility — you'd only pay £2. The third, even less. The demand curve captures this willingness to pay.

Exam Tip

If asked to explain the shape of the demand curve (a common 4-mark question), reference diminishing marginal utility AND the income/substitution effects for full marks.

Combined Demand & Supply — Equilibrium

When demand and supply are drawn together, the intersection gives the equilibrium price (P*) and equilibrium quantity (Q*).

EQUILIBRIUM DEFINED

Equilibrium is where Qd = Qs. There is no tendency for price to change — the market clears. At any other price: if P > P*, there is excess supply (surplus); if P < P*, there is excess demand (shortage).

Applying Shifts: Demand Increase

Scenario: A rise in consumer incomes increases demand for restaurant meals. Trace the effect on the market.

Income ↑

D shifts right D₁→D₂

Excess demand at P₁

P* rises to P₂, Q* rises to Q₂

Applying Shifts: Supply Decrease

Scenario: A drought destroys wheat harvests. Trace the effect on the wheat market.

Drought → bad harvest

Supply shifts LEFT (S₁→S₂)

Excess demand at original P*

P* rises, Q* falls

ALWAYS STATE

Which curve shifts and in which direction

What happens to P* (up or down)

What happens to Q* (up or down)

Reference your diagram

Examiner Alert

Do NOT say "price increases because supply decreased." That is circular. The chain must show: supply shifts left → excess demand at original price → price is bid up → new equilibrium.

AO4 Evaluation Toolkit

For higher-mark questions (8–12 marks), you must evaluate your analysis. Use these points:

Evaluation PointHow to Apply It

Ceteris paribus assumptionIn reality, multiple factors change simultaneously — the predicted shift may be offset by a simultaneous change on the other side

Price elasticity of demandThe extent to which P* and Q* change depends on PED — inelastic demand means a supply shift mainly raises price

Time lagsSupply may be slow to respond — especially in agriculture or capital-intensive industries

Relative size of the shiftA small income increase may have a negligible effect on demand if the good is a luxury with elastic demand

Second-round effectsA rise in equilibrium price may trigger further changes — e.g. wage demands, substitute goods markets

Practice Question

[4 marks — typical Paper 1 Section A]

The price of tea falls significantly. Using a supply and demand diagram, analyse the likely effect on the market for coffee.

Hint: tea and coffee are substitutes.

1

Tea and coffee are substitutes (positive cross-price elasticity of demand).

2

Price of tea falls → tea becomes relatively cheaper → consumers switch from coffee to tea (substitution effect).

3

Demand for coffee decreases — the demand curve for coffee shifts LEFT (D₁ → D₂).

4

At the original equilibrium price, there is now excess supply of coffee → price is bid down.

5

New equilibrium: lower P* and lower Q* for coffee. [Must draw labelled diagram with supply curve, D₁ (dashed), D₂, original and new equilibrium points marked.]

Practice Question 2

[5 marks — typical Paper 1 data response]

The UK government introduces a new subsidy for electric vehicle (EV) manufacturers. Using a diagram, explain the effect on the market for electric vehicles.

1

A subsidy reduces firms' production costs — it is a supply-side determinant (PINTSWC: T).

2

Supply of EVs increases — the supply curve shifts RIGHT (S₁ → S₂). More EVs are supplied at every price level.

3

At original P*, there is now excess supply → price is driven down.

4

New equilibrium: lower price (P₁ → P₂) and higher quantity (Q₁ → Q₂).

5

Evaluation: The extent of the price fall depends on PED — if demand is inelastic (early adopters), the price fall may be small but quantity increase larger. Also, the subsidy may attract new EV firms into the market over time, further shifting supply.

Summary

Key Definitions to Memorise

TermDefinition

DemandQuantity willing & able to buy at a given price, in a given time period

SupplyQuantity willing & able to sell at a given price, in a given time period

Movement alongCaused by a change in the price of the good itself

Shift of curveCaused by a change in any non-price determinant

Demand Shifters

PIYEN: Price of related goods, Income, Your tastes, Expectations, Number of consumers

Supply Shifters

PINTSWC: Productivity, Input costs, Number of firms, Taxes/subsidies, Seasons, World prices, Costs/regulation

Exam Tip

Every diagram answer needs: labelled axes (Price, Quantity), named curves (D, S), dashed original curve, solid new curve, original and new equilibrium points, and dashed lines to axes. A diagram without labels scores zero for the diagram mark.