Demand and Supply (Cambridge (CIE) A Level Business): Revision Note

Factors influencing demand

• Demand refers to the number of goods or services customers are willing and able to buy at a given price

• There is an inverse relationship between the quantity demanded by customers and price 

  • As price increases, the quantity demanded decreases

  • As price decreases, the quantity demanded increases

  • Hence the demand curve slopes downwards from left to right

• This is illustrated in the diagram below

A simple demand curve

• An increase in price from £10 to £15 leads to a movement up the demand curve from point A to B

  • Due to the increase in price, the quantity demanded (QD) has fallen from 10 to 7 units

• A decrease in price from £10 to £5 leads to a movement down the demand curve from point A to point C

  • Due to the decrease in price, the QD has increased from 10 to 15 units

Factors leading to a change in demand

• A change in price leads to a movement along the demand curve

• However, a change in any other factors affecting demand will shift the entire demand curve to the left or right

  • These are called non-price factors affecting demand

Non-price factors affecting demand

• For example, if a firm increases its Instagram advertising, there will be an increase in demand as more consumers become aware of the product

  • This is a shift in demand from D to D₁. The price remains unchanged at £7 but the demand has increased from 15 to 25 units

Illustreating changes in non-price factors

• The initial demand curve is seen at D

  • At a price of £7, 15 units are demanded

• If price remains constant at £7 but demand decreases due to one of the non-price factors of demand (e.g. decreasing incomes), the entire demand curve shifts to the left from D to D₂

  • Demand has decreased from 15 units to 5 units

• If price remains constant at £10 but demand increases due to one of the non-price factors of demand (e.g. increased advertising expenditure), the entire demand curve shifts to the right from D to D₃

  • Demand has increased from 15 units to 25 units

Non-price factors affecting demand

Factors influencing supply

• Supply is the number of goods or services businesses are willing to sell at a given price in a specific time period

• There is a direct relationship between supply and price 

  • As price increases, the quantity supplied increases

  • As price decreases, the quantity supplied decreases

  • At higher prices, businesses are incentivised to supply more of the product

  • Hence the supply curve slopes upwards from left to right

A simple supply curve

• An increase in price from £7 to £9 leads to a move up the supply curve from point A to B

  • Due to the increase in price, the quantity supplied (QS) has increased from 10 to 14 units

• A decrease in price from £10 to £7 leads to a movement down the supply curve from point A to point C

  • Due to the decrease in price, the quantity supplied (QS) has decreased from 10 to 7 units

Factors leading to a change in supply

• A change in price causes a movement along the supply curve

• A change in any other factor affecting supply will shift the entire supply curve to the left or right

  • These are called non-price factors affecting the supply 

Non-price factors affecting supply

• E.g. If a firm's costs of production increase due to the increase in the price of a key resource, then there will be a decrease in supply as the firm is unable to afford to produce as many products

• This causes a shift in supply from S to S₁. The price remains unchanged at £7 but the supply has decreased from 10 to 2 units

Changes in non-price factors

• The initial supply curve is seen at S

  • At a price of £7, 10 units are supplied

• If the price remains constant at £7 but supply decreases due to one of the non-price factors of supply (e.g. worker's wages increase), the entire supply curve shifts to the left from S to S₁

  • Supply has decreased from 10 to 2 units

• If the price remains constant at £7 but supply increases due to one of the non-price factors of supply (e.g. costs of production fall), the entire supply curve shifts to the right from S to S₂

  • Supply has increased from 10 to 20 units

Non-price factors affecting supply

Interactions between demand, supply and price

• In a market, prices for goods/services are determined by the interaction of demand & supply 

• A market is any place that brings buyers & sellers together to trade at an agreed price

  • Markets can be physical (e.g. McDonald's) or virtual (e.g. eBay)

  • Buyers agree on the price by purchasing the good/service

  • If they do not agree on the price then they do not purchase the good/service

• Based on this interaction with buyers, sellers will gradually adjust their prices until there is an equilibrium price and quantity that works for both parties

  • At the equilibrium price, sellers will be satisfied with the rate/quantity of sales

  • At the equilibrium price, buyers are satisfied that the product provides benefits worth paying for

Equilibrium

• If the price is set at £20, demand will equal supply and equilibrium is reached

  • 600 units will be demanded and supplied

  • If the price was set above equilibrium, supply would be greater than demand and there would be a surplus

  • If the price was set below equilibrium demand would be greater than supply and there would be a shortage

Dynamic changes in markets

• There are 4 diagrams that can be used to show the causes and consequences of changes to the non-price factors of demand and supply 

A rise in demand

• The original equilibrium was at P₁ and Q₁

• A rise in demand causes the demand curve to shift to the right from D₁→ D₂ (perhaps due to an increase in home working)

• At the original price of P1, there is now a shortage as demand exceeds the supply

• The shortage causes prices to rise from P₁ to P₂

• A new equilibrium develops at a price of P₂ and a quantity of Q₂ units

• The business revenue (P x Q) has changed from P₁Q₁ to P₂Q₂

A fall in demand

• The original equilibrium was at P₁ and Q₁

• A fall in demand causes the demand curve to shift to the left from D₁→ D₂ (perhaps due to an external shock)

• At the original price ofP1, there is now a surplus as supply exceeds demand

• The surplus causes prices to fall from  P₁ to P₂

• A new equilibrium develops at a price of P₂ and a quantity of Q₂ units

• The business revenue (P x Q) has changed from P₁Q₁ to P₂Q₂

A rise in supply

• The original equilibrium was at P₁ and Q₁

• A rise in supply causes the supply curve to shift to the right from S₁→ S₂ (perhaps due to an increase in productivity)

• At the original price of P₁, there is now a surplus as supply exceeds demand

• The surplus causes prices to fall from  P₁ to P₂

• A new equilibrium develops at a price of P₂ and a quantity of Q₂ units

• The business revenue (P x Q) has changed from P₁Q₁ to P₂Q₂

A fall in supply

• The original equilibrium was at P₁ and Q₁

• A fall in supply causes the supply curve to shift to the left from S₁→ S₂ (perhaps due to an increase in the costs of production)

• At the original price of P₁, there is now a shortage as demand exceeds the supply

• The shortage causes prices to rise from P₁ to P₂

• A new equilibrium develops at a price of P₂ and a quantity of Q₂ units

• The business revenue (P x Q) has changed from P₁Q₁ to P₂Q₂