Cambridge IGCSE Economics (0455): Study Notes

Chapter 2.6: Price Changes (The Dynamic Market)

Hello future economist! This chapter is where everything we learned about Demand and Supply comes together. Prices in real life are almost always changing—the cost of bananas might drop next week, or concert tickets might suddenly get more expensive. Why does this happen?


In this section, we will learn how changes in market conditions (the factors that affect Demand and Supply) cause prices to move, and what the consequences are for the amount of goods bought and sold. This skill is vital because understanding price changes helps us understand the allocation of resources.

1. Quick Review: Finding the Balance (Equilibrium)

Before we look at changes, we must remember the resting point.

What is Market Equilibrium?

Market Equilibrium is the point where the quantity demanded (QD) exactly equals the quantity supplied (QS). There is no pressure for the price to change. We call the price at this point the Equilibrium Price (P\(_e\)) and the quantity the Equilibrium Quantity (Q\(_e\)).


  • If Price > P\(_e\): We have a Surplus (QS > QD). Producers have too much stock, so they drop the price.
  • If Price < P\(_e\): We have a Shortage (QD > QS). Consumers fight over limited stock, bidding the price up.

The market constantly adjusts until it gets back to equilibrium. But what happens when the whole Demand or Supply curve moves?

Key Takeaway: Prices change only when the existing equilibrium is disturbed, usually by a shift in one or both curves.

2. Causes of Price Changes: Shifts in Demand (2.6.1)

A change in price is caused by a change in market conditions (the factors that are not the price itself). For demand, these non-price factors (like income or tastes) cause the entire demand curve to shift.

A. Increase in Demand (Demand Curve Shifts to the Right)

An increase in demand means consumers want to buy more at every possible price. This is caused by:

  • An increase in income (for normal goods).
  • A successful advertising campaign (change in tastes/preferences).
  • The price of a substitute good increasing.
  • The price of a complementary good decreasing.
  • An increase in population.

Step-by-Step Effect:

  1. The demand curve shifts right (D1 to D2).
  2. At the original price (P1), demand now exceeds supply (QD > QS). This creates a shortage.
  3. Because of the shortage, buyers are willing to pay more, pushing the price up.
  4. A new equilibrium is reached at P2 and Q2.

Real-World Example: Imagine the government announces a tax reduction (higher income). People demand more new cars. The demand curve for cars shifts right, leading to higher prices and more cars sold.

B. Decrease in Demand (Demand Curve Shifts to the Left)

A decrease in demand means consumers want to buy less at every possible price.

  • A decrease in income (for normal goods).
  • A negative news report about the product (change in tastes).
  • The price of a substitute good decreasing.

Step-by-Step Effect:

  1. The demand curve shifts left (D1 to D2).
  2. At the original price (P1), supply now exceeds demand (QS > QD). This creates a surplus.
  3. Sellers must drop their price to get rid of the surplus.
  4. A new equilibrium is reached at a lower price (P2) and lower quantity (Q2).

Memory Aid for Demand: A shift to the Right = Rise in Price and Quantity. A shift to the Left = Less Price and Quantity.

Key Takeaway: If demand shifts, price and quantity move in the same direction as the shift.

3. Causes of Price Changes: Shifts in Supply (2.6.1)

A change in price can also be caused by a shift in supply, due to changes in non-price factors affecting producers (like production costs or technology).

A. Increase in Supply (Supply Curve Shifts to the Right)

An increase in supply means producers are willing to supply more at every possible price. This is typically a good thing for consumers and is caused by:

  • A decrease in the costs of production (e.g., raw materials become cheaper).
  • An improvement in technology.
  • A subsidy granted by the government.
  • Favourable weather (for agricultural products).

Step-by-Step Effect:

  1. The supply curve shifts right (S1 to S2).
  2. At the original price (P1), supply now exceeds demand (QS > QD). This creates a surplus.
  3. Producers drop prices to clear the excess stock.
  4. A new equilibrium is reached at a lower price (P2) and higher quantity (Q2).

Real-World Example: A new machine makes producing phones cheaper (improved technology). The supply of phones shifts right. Consequences: phones are sold at a lower price, and more are bought.

B. Decrease in Supply (Supply Curve Shifts to the Left)

A decrease in supply means producers offer less at every price. This is usually due to factors making production harder or more expensive:

  • An increase in the costs of production (e.g., higher wages or electricity bills).
  • An indirect tax imposed by the government.
  • Unfavourable weather or natural disasters.

Step-by-Step Effect:

  1. The supply curve shifts left (S1 to S2).
  2. At the original price (P1), demand now exceeds supply (QD > QS). This creates a shortage.
  3. Buyers compete, driving the price up.
  4. A new equilibrium is reached at a higher price (P2) and lower quantity (Q2).

Memory Aid for Supply: Think of the cost of production. If costs go UP, Supply shifts LEFT, and Price goes UP. (The shifts are opposite to the resulting price change, unlike demand).

Key Takeaway: If supply shifts, price and quantity move in opposite directions (except for the quantity, which always moves in the direction of the shift).

4. Consequences of Price Changes (2.6.2)

The consequence of any shift in demand or supply is a definite change in the new Equilibrium Price (P\(_e\)) and the new Equilibrium Quantity (Q\(_e\)). This is the mechanism by which resources are reallocated in the economy.

Don't worry if this seems tricky at first; drawing the diagrams will make it clear!

Summary Table of Consequences (Use this for quick checks!)

Remember: P means Equilibrium Price. Q means Equilibrium Quantity (Sales).

Change in Market Condition Curve Shift Consequence on P\(_e\) Consequence on Q\(_e\) (Sales)
Demand Increases (Right) Demand Curve Right Rises (P↑) Rises (Q↑)
Demand Decreases (Left) Demand Curve Left Falls (P↓) Falls (Q↓)
Supply Increases (Right) Supply Curve Right Falls (P↓) Rises (Q↑)
Supply Decreases (Left) Supply Curve Left Rises (P↑) Falls (Q↓)

The Importance of the Price Mechanism (Resource Allocation)

The key consequence of these price changes is that they act as signals in the market economy:

  1. Signalling Function: A rising price signals to producers that this good is now more profitable (or scarcer). A falling price signals the opposite.
  2. Incentive Function: The prospect of higher profits (from rising prices) acts as an incentive for producers to increase supply, thus reallocating resources (Factors of Production) toward the good that is more in demand.

Example: If the price of housing rises rapidly (due to increased demand), this signals to builders (producers) that they should dedicate more land, labour, and capital to building houses rather than commercial offices.

Did you know? This signalling and incentive function is often called "The Invisible Hand" of the market, a term coined by economist Adam Smith.

Common Mistake to Avoid: When asked about the consequences of a shift, students often describe the *causes* again. The consequence is the resulting movement of the new equilibrium (P\(_e\) and Q\(_e\)). Always focus your answer on the final market state!

Key Takeaway: Price changes are essential for solving the 'What to produce' and 'How much to produce' questions by directing resources where they are most needed or profitable.