The Price System and the Microeconomy: Demand and Supply Curves (2.1)

Hello and welcome to the foundation of Microeconomics! Understanding Demand and Supply is like learning the alphabet—it's essential for reading the entire language of Economics. These curves explain how millions of buyers and sellers interact to determine prices in a market, which is how resources are allocated in most modern economies. Don't worry if diagrams seem intimidating at first; we will break down what causes these lines to move!

Key Concept 1: Understanding Demand (D)

Demand isn't just wanting something; it has a very specific definition in Economics.

Definition of Effective Demand (2.1.1)

Effective Demand is the willingness AND ability of consumers to purchase a product at a given price. If you want a *sports car* but can't afford it, that's just a desire, not effective demand.

The Law of Demand

The Law of Demand states that there is an inverse relationship between the price of a good and the quantity demanded (ceteris paribus).

  • When Price (\(P\)) goes UP, Quantity Demanded (\(Q_D\)) goes DOWN.
  • When Price (\(P\)) goes DOWN, Quantity Demanded (\(Q_D\)) goes UP.

Think about your favourite snack: if the price doubles, you'll probably buy less of it!

Individual vs. Market Demand (2.1.2)
  • Individual Demand: The demand schedule/curve for a single consumer.
  • Market Demand: The total demand for a product, calculated by summing up (horizontally adding) the quantity demanded by all individual consumers at every price level.
Quick Review: Why does the Demand Curve slope downward?

1. The Income Effect: If the price of a product falls, your *real income* (your purchasing power) effectively increases, allowing you to buy more of that product.
2. The Substitution Effect: If the price of product A falls, it becomes relatively cheaper compared to alternatives (substitutes), so consumers switch from the substitutes to product A.

Key Concept 2: The Determinants of Demand (Shifts) (2.1.3, 2.1.5)

The demand curve assumes ceteris paribus (*all other things remain equal*). A change in any factor other than the price of the good itself will cause the *entire* demand curve to shift.

We can use the acronym P.I.R.T.E. to remember the main shift factors:

P.I.R.T.E. - Causes of a Shift in the Demand Curve (D)

P: Population (Size and Structure)

  • More consumers means more demand (shift right). Example: An increase in immigration increases the demand for housing.

I: Income of Consumers

  • For most goods (Normal Goods): Income up, Demand up (shift right). Example: As people earn more, they buy more branded clothing.
  • For some goods (Inferior Goods): Income up, Demand down (shift left). Example: If you suddenly earn a lot more, you might stop taking the bus (the inferior good) and start taking taxis or driving your own car.

R: Related Goods (2.4.3 connection)

Related goods affect demand because consumers often use them together or swap between them.

  • Substitutes (Alternative Demand): Goods used instead of each other. *Example: Tea and Coffee.* If the price of *Coffee* rises, the demand for *Tea* shifts right.
  • Complements (Joint Demand): Goods used together. *Example: Cars and Petrol.* If the price of *Petrol* rises, the demand for *Cars* shifts left.

T: Tastes and Preferences (including Advertising)

  • If a good becomes more fashionable or a successful advertising campaign is run, demand increases (shift right). Example: A new scientific study claims red wine is healthy, increasing demand.

E: Expectations of Future Prices

  • If consumers expect the price to rise next month (e.g., before a tax increase), current demand increases (shift right).

Key Takeaway for Demand: The Law of Demand explains the *movement* along the curve. PIRTE explains the *shift* of the entire curve.

Key Concept 3: Understanding Supply (S)

Supply refers to the amount of a good or service that producers are willing and able to offer for sale at various prices.

The Law of Supply

The Law of Supply states that there is a direct relationship between the price of a good and the quantity supplied (ceteris paribus).

  • When Price (\(P\)) goes UP, Quantity Supplied (\(Q_S\)) goes UP.
  • When Price (\(P\)) goes DOWN, Quantity Supplied (\(Q_S\)) goes DOWN.

Why? Because higher prices usually mean higher profit opportunities, encouraging producers to manufacture and sell more.

Individual vs. Market Supply (2.1.2)
  • Individual Supply: The supply schedule/curve for a single firm.
  • Market Supply: The total supply for a product, calculated by summing up (horizontally adding) the quantity supplied by all individual firms at every price level.

Key Concept 4: The Determinants of Supply (Shifts) (2.1.4, 2.1.6)

Similar to demand, if a factor *other than the product's own price* changes, the entire supply curve shifts.

We can use the acronym C.O.S.T. S.I.N. to remember the main shift factors (or adapt to T.I.M.B.E.R. if you prefer). Let's stick to the factors most frequently examined:

Determinants Leading to a Shift in the Supply Curve (S)

C: Cost of Production

  • If costs (e.g., wages, raw material prices, rent) increase, profits fall. Supply shifts left (decreases). Example: A sudden increase in global oil prices makes transporting goods more expensive.

T: Technology and Productivity

  • An improvement in technology means firms can produce more efficiently, lowering costs. Supply shifts right (increases). Example: A new automated assembly line reduces the time needed to build a car.

N: Number of Firms (Competition)

  • If more firms enter the market (low barriers to entry), market supply increases (shift right).

G: Government Action (Taxes and Subsidies)

  • Taxes (Indirect/Specific taxes): Increase costs for firms. Supply shifts left.
  • Subsidies: Decrease costs for firms (making production cheaper). Supply shifts right.

R: Related Supply (Joint Supply / Derived Demand Connection - 2.4.3)

  • Joint Supply: When one product is produced, another product is automatically produced too. *Example: Beef and leather.* If the demand for *beef* rises, leading to more beef production, the supply of *leather* also shifts right, even if the price of leather hasn't changed.

E: Expectations (Future Price)

  • If producers expect the price to rise next month, they may hold back stock now to sell later. Current supply shifts left (decreases).

Key Takeaway for Supply: Supply increases (shifts right). Supply decreases (shifts left). Factors outside of the direct profit price determine the shift.

Key Concept 5: The Crucial Distinction: Movement vs. Shift (2.1.7)

This is one of the most important differentiations you must make in AS Economics. Students often confuse a change in Quantity Demanded/Supplied with a change in Demand/Supply.

1. Movement Along the Curve

A movement along a fixed demand or supply curve is caused only by a change in the product's own price.

  • Demand: A fall in price causes an expansion (increase in quantity demanded). A rise in price causes a contraction (decrease in quantity demanded).
  • Supply: A rise in price causes an extension (increase in quantity supplied). A fall in price causes a contraction (decrease in quantity supplied).

Analogy: Think of the curve as a single road. If the price changes, you move to a different point *along that same road*.

2. Shift of the Curve

A shift of the entire curve (either left or right) is caused by a change in any of the non-price determinants (PIRTE for Demand, COST SIN for Supply).

  • Demand Shift (Left/Right): Caused by changes in income, tastes, population, etc. This is called a change in Demand.
  • Supply Shift (Left/Right): Caused by changes in costs, technology, subsidies, etc. This is called a change in Supply.

Analogy: If a non-price factor changes (e.g., your income doubles), you are now on a completely different, new road (a shifted curve).

Common Mistake to Avoid!

Do NOT say that an increase in the price of *Petrol* causes a decrease in the *Quantity Demanded* of cars. The price change is for *Petrol* (a related good), not *Cars*. Therefore, it causes a decrease in **Demand** (a shift left) for cars.

Quick Review Box (2.1)

What affects What?

  • Change in OWN Price \(\rightarrow\) Causes a MOVEMENT along the curve \(\rightarrow\) Changes Quantity Demanded/Supplied.
  • Change in NON-Price Factor \(\rightarrow\) Causes a SHIFT of the curve \(\rightarrow\) Changes Demand/Supply itself.

Did you know? The concept of demand and supply curves was popularized by the great economist Alfred Marshall in the late 19th century. He compared them to the two blades of a pair of scissors, stating that you cannot say whether the top blade (supply) or the bottom blade (demand) determines the price—it takes both!