The demand curve and what shifts it

Demand is the quantity consumers are willing and able to buy at each price in a given period. The demand curve slopes downwards because of (i) the income effect — a lower price raises real income; (ii) the substitution effect — the good is now cheaper relative to rivals; and (iii) diminishing marginal utility — each extra unit is worth less, so you only buy it at a lower price.

Conditions of demand (PIRATES): Population · Income · Related goods (substitutes and complements) · Advertising · Tastes and fashion · Expectations of future prices · Seasons.

Exam killer: writing demand rises because price falls. That is an extension of demand, not a rise in demand. Use the words precisely — examiners are ruthless about it.

The supply curve and what shifts it

Supply is the quantity producers are willing and able to sell at each price. It slopes upwards because a higher price (i) raises the profit per unit, so existing firms expand and new firms enter, and (ii) covers the rising marginal cost of extra output (diminishing returns, 4.1.4).

Conditions of supply (PINTSWC): Productivity · Indirect taxes · Number of firms · Technology · Subsidies · Weather/shocks · Costs of production.

• An indirect tax raises costs → supply shifts left (up by the tax).
• A subsidy cuts costs → supply shifts right (down by the subsidy).

Joint supply (beef and leather) and competitive supply (a farmer's field can grow wheat or barley) also shift supply — a rise in the price of barley reduces the supply of wheat.

Movement or shift?

Tap an event, then tap what it does to the market.

Equilibrium and the price mechanism

Equilibrium is where Qd = Qs — the market clears and there is no tendency to change. Away from it, price does the work:

• Price above Pe → excess supply (a surplus). Unsold stock forces producers to cut price; demand extends, supply contracts, until the market clears.
• Price below Pe → excess demand (a shortage). Consumers bid the price up; supply extends, demand contracts.

This is the price mechanism, and it does three jobs at once:

• Signalling — price conveys information about relative scarcity to everyone at once.
• Incentive — a high price rewards producers for supplying more and consumers for economising.
• Rationing — a scarce good goes to those willing and able to pay most.

Evaluate: rationing by price is efficient but not equitable — the poor are rationed out first. That single sentence is the bridge from 4.1.3 to 4.1.7 and 4.1.8.

Complements in action

Price elasticity of demand

• |PED| > 1 → elastic (luxuries, goods with close substitutes, long time period, big share of income).
• |PED| < 1 → inelastic (necessities, addictive goods, no substitutes, short run, tiny share of income).
• |PED| = 1 → unit elastic; 0 → perfectly inelastic; ∞ → perfectly elastic.

Determinants — SPLAT: Substitutes · Percentage of income · Luxury or necessity · Addictive/habit-forming · Time.

Your turn — calculate PED

PED and total revenue

• Demand inelastic (|PED| < 1): Q falls proportionately less than P rises → raise price to raise revenue. This is why the government taxes cigarettes and fuel, and why train operators can push up peak fares.
• Demand elastic (|PED| > 1): Q falls proportionately more than P rises → cut price to raise revenue. A supermarket discounting branded cereal is banking on this.
• Demand unit elastic: revenue is unchanged (it is at its maximum on a straight-line demand curve).

Careful — revenue is not profit. Cutting price to sell more raises revenue only if demand is elastic, and raises profit only if the extra revenue also beats the extra cost of the extra units (MR > MC).

Price up or price down?

Income and cross elasticity of demand

• YED positive → normal good. If YED > 1 it is a luxury (restaurant meals, foreign holidays — demand is income elastic). If 0 < YED < 1 it is a necessity (bread, electricity).
• YED negative → inferior good: demand falls as income rises (bus travel, supermarket value ranges).

• XED > 0: substitutes (Coke and Pepsi). A large positive XED means fierce rivalry — very relevant to oligopoly (4.1.5).
• XED < 0: complements (printers and ink; cars and petrol).

Why firms care: a supermarket with a portfolio of luxury (high YED) goods is very exposed in a recession; a discounter selling inferior goods can actually grow. That is a ready-made evaluation point in any macro-to-micro question.

Your turn — calculate YED

Your turn — calculate XED

Price elasticity of supply

Determinants of PES — how easily can a firm expand output?

• Time period — the biggest one. In the very short run supply is close to perfectly inelastic (a fisherman's catch is already landed); in the long run all factors are variable, so supply is far more elastic.
• Spare capacity and stocks — plenty of both → elastic supply.
• Factor mobility — can workers and machines be switched into this good quickly?
• Ease of entry — low barriers → new firms can pile in.

Classic application: housing supply in the UK is highly inelastic (planning restrictions, slow build times), so a rise in demand feeds mostly into price, not quantity. Agricultural supply is inelastic in the short run, which is why crop failures cause price spikes — and why farm incomes are so volatile.

Your turn — calculate PES

Read the elasticity value

Tap an elasticity value on the left, then what it tells you.

Consumer and producer surplus

The demand curve shows what consumers are willing to pay; the supply curve shows the price at which producers are willing to sell.

• Consumer surplus = willingness to pay − price actually paid. On the diagram: the area below D and above Pe.
• Producer surplus = price received − the minimum price the producer would have accepted. The area above S and below Pe.
• Their sum is total welfare (community surplus), and in a competitive market with no externalities it is maximised at equilibrium — a first look at allocative efficiency.

How elasticity changes the split: the more inelastic demand is, the larger consumer surplus (people would have paid far more). A monopolist raising price above Pe converts part of consumer surplus into producer surplus and destroys the rest as deadweight loss (4.1.5).

Why is equilibrium efficient?

Which good would you tax?

The big ideas to know

You have covered the whole of AQA 4.1.3. Press Finish to see your score.