Demand, supply & equilibrium

In a market, demand is how much consumers will buy at each price; supply is how much producers will sell. Both depend on price:

• Law of demand — as price rises, quantity demanded falls (the demand curve slopes down).
• Law of supply — as price rises, quantity supplied rises (the supply curve slopes up).

The price mechanism: excess demand (a shortage) pushes price up; excess supply (a surplus) pushes price down. Prices ration, signal and incentivise — moving the market back to equilibrium.

What shifts demand & supply?

A change in a good's own price is a movement along the curve. A change in any other factor shifts the whole curve. These other factors are the determinants:

• Demand shifters — incomes, tastes/fashion, prices of substitutes & complements, population, advertising.
• Supply shifters — costs of production, technology, taxes & subsidies, weather (for farming).

Watch out: "the price of oranges rose so people bought fewer" is a movement along the demand curve. "Incomes rose so people bought more oranges at every price" shifts the whole demand curve to the right.

Shift demand, shift supply, or move along?

Tap a change, then tap what it does. Remember: the good's own price only moves you along a curve.

Price elasticity of demand (PED)

PED measures how much quantity demanded responds to a change in price. It matters for firms deciding whether to change prices.

• PED > 1 — demand is elastic (very responsive): quantity changes by a bigger % than price. Often luxuries or goods with many substitutes.
• PED < 1 — demand is inelastic (unresponsive): quantity changes by a smaller % than price. Often necessities or goods with few substitutes.
• PED = 1 — unitary elastic.

What does a PED tell us?

Your turn — PED

Price elasticity of supply (PES)

PES measures how much quantity supplied responds to a change in price — how easily producers can raise or cut output.

• PES > 1 — supply is elastic: firms can increase output quickly and cheaply (spare capacity, easily stored goods).
• PES < 1 — supply is inelastic: output is hard to expand quickly, e.g. farming, or where factors are limited.

Your turn — PES

Competition & market failure

Competition is rivalry between firms for customers. More competition tends to bring lower prices, better quality and more choice for consumers, and pushes firms to be more efficient.

Market failure is when a market allocates resources inefficiently — the free market fails to deliver the best outcome for society. Key examples:

• Externalities — costs (or benefits) that fall on third parties. Pollution is a negative externality.
• Under-provision of public goods (e.g. street lighting) and merit goods (e.g. education).
• Monopoly power — one dominant firm can raise prices and restrict output.

Intervention: government may correct market failure with taxes (on pollution), subsidies (for merit goods) and regulation to change what firms and consumers do.

Spot the market failure

Equilibrium & percentage change

At the equilibrium price, quantity demanded exactly equals quantity supplied. If the price is set too high there is a surplus; too low and there is a shortage — and the price mechanism moves the price back.

Economists often need to work out a percentage change in quantity to describe how a market has responded:

Why it matters: the % change in quantity demanded is the top of the PED formula. Getting the base value right (the original quantity) is essential to the calculation.

Your turn — % change

Match each term to its meaning

Tap a description on the left, then its matching term on the right.

The big ideas to know

You've covered the core of Edexcel GCSE Economics A — How the Market Works. Press Finish to see your score.