Causes & Consequences of Price Changes (Cambridge (CIE) IGCSE Economics): Revision Note

Dynamic markets

• Real-world markets are constantly changing and are referred to as dynamic markets

• Market equilibrium can change every few minutes in some markets (e.g. stocks and shares), or every few weeks or months in others (e.g. clothing).

•  Any change to a condition of demand or supply will temporarily create disequilibrium and market forces will then seek to clear the excess demand or supply

Changes to demand that increase price

• During lockdowns associated with the Covid-19 pandemic, furniture retailers experienced unexpectedly high demand for their products (especially desks and sofas)

Diagram analysis

• Due to the Covid-mandated change of working from home, consumers experienced a temporary change in taste as they sought to set up comfortable home offices

  • This led to an increase in demand for desks from D₁→D₂ 

• At the original market clearing price of P₁, a condition of excess demand now exists

  • The demand for desks is greater than the supply 

• In response, suppliers raise prices to P₂

  • The excess demand is cleared and the new market quantity is Q₂

  • Both the equilibrium price (P₂) and the equilibrium quantity (Q₂) are higher than before

Changes to supply that increase price

• In September 2022, Hurricane Fiona destroyed much of Puerto Rico's crop of plantains (a necessity in the diet of local people)

Diagram analysis

• In the aftermath of Hurricane Fiona, Puerto Rico is experiencing a supply shock in its plantain market

  • This causes a decrease in supply of S₁→S₂ 

• At the original market clearing price of P₁, a condition of excess demand now exists (shortage)

  • The demand for plantain is greater than the supply 

• In response, sellers in Puerto Rico raise prices to P₂

  • The equilibrium price (P₂) is higher and the equilibrium quantity (Q₂) is lower than before

  • The excess demand in the market has been cleared

Changes to demand that decrease price

• Demand for lobsters in Maine, USA has been falling steadily in recent months

• This has resulted in a price fall from $12.35 per pound on April 1st to $9.35 per pound on May 1st

Diagram analysis

• In recent months, the USA has been experiencing an increasing rate of inflation

  • Inflation lowers the purchasing power of money in a consumer's pocket and, therefore, effectively reduces their real income

  • With reduced real income, fewer luxuries are consumed

  • This led to a decrease in demand for lobsters from D₁→D₂ 

• At the original market clearing price of P₁, a condition of excess supply now exists

  • The demand for lobsters is less than the supply 

• In response, suppliers gradually reduce prices to P₂

  • Both the equilibrium price (P₂) and the equilibrium quantity (Q₂) are lower than before

  • The excess supply in the market has been cleared

Changes to supply that decrease price

• In order to help meet their climate targets and lower energy costs for households, the EU is providing subsidies for solar panels 

Diagram analysis

• To help meet its climate change targets and lower household energy bills, the EU has provided a subsidy to solar panel retailers

  • This causes an increase in supply of S₁→S₂ 

• At the original market clearing price of P₁, a condition of excess supply now exists (surplus)

  • The supply of solar panels is greater than the demand 

• In response, sellers in the EU lower prices to P₂

  • The equilibrium price (P₂) is lower and the equilibrium quantity (Q₂) is higher than before

  • The excess supply in the market has been cleared

The effect of price changes on sales

• In any market, changes in price have a direct impact on sales (quantity demanded and quantity supplied).

  • A rise in price usually leads to a fall in quantity demanded

  • A fall in price usually leads to a rise in quantity demanded

• This is known as the law of demand, and it underpins how prices influence consumer purchasing decisions and firm revenue

If prices rise

• Consumers may reduce purchases or switch to cheaper alternatives

  • Quantity demanded falls, leading to lower sales for firms

  • For example, when mobile phone prices rose in Egypt due to import taxes, many consumers delayed upgrading, and local sales fell.

• Firms may lose market share if competitors keep prices low

If prices fall

• Goods become more affordable to a larger number of consumers

  • Quantity demanded rises, which can increase sales volume

  • For example, a discount on ride-hailing apps in Mexico City led to a surge in bookings, increasing total sales for the platform

• This can benefit firms with price-elastic products

The impact depends on elasticity

• Price elasticity of demand (PED) measures how responsive the quantity demanded of a good or service is to a change in its price

  • The extent of change in sales depends on the price elasticity of demand (PED):

    • If demand is elastic → a small price drop causes a large increase in sales

    • If demand is inelastic → a price change has little effect on sales

• Read more on price elasticity of demand here