Chapter 3

The market system 1

demand and supply
analysis

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CHAPTER CONTENTS
LEARNING OUTCOMES -------------------------------------------------- 35
THE DEFINITION OF A MARKET ---------------------------------------- 36
THE DEMAND CURVE ---------------------------------------------------- 37
THE SUPPLY CURVE ----------------------------------------------------- 41
FORMATION OF EQUILIBRIUM PRICE --------------------------------- 44
DEMAND AND SUPPLY ANALYSIS -------------------------------------- 45

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LEARNING OUTCOMES
(a) Identify the equilibrium price in a product or factor markets likely to result
from specified changes in conditions of demand or supply.

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THE DEFINITION OF A MARKET

and does not necessarily refer to a
physical location, but instead a place whereby potential buyers and sellers meet for
the purposes of exchanging goods / services.
Examples include:
Type of market

Goods / services exchanged

Product market
Commodity market
Financial market
Factor market
Note: This chapter focuses upon product markets, the term goods is used to
denote the provision of tangible goods and intangible services.

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THE DEMAND CURVE

Demand for a good is the quantity of that good that potential purchasers would be
willing and able to buy, at a given price.
The law of demand states that as the price of a good falls, ceteris paribus, the
quantity demanded will increase.
Graphical representation

Price $

Quantity (Units)

Market demand
The total quantity of a product that all purchasers would want to buy at each price.

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Determinants of demand (excluding price)

1.

Household income

Income type

Variable factor

Gross income
Disposable income
Discretionary income
As household income increases
increase. Examples include

As household income increases

decrease. Examples include

2.

Expectations for the future

3.

Availability of substitutes

4.

Complementary Goods

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Discussion 1
Substitute goods

Complementary goods

Try to come up with your own examples for substitute and complementary
goods.
5.

Tastes and fashions

6.

Population

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Changes in demand
Examination questions will typically require students to interpret the impact on
demand following changes to price and the conditions of demand. Changes may
affect the demand curve in one of two ways:
(i)

Movement along the demand curve (extensions/contractions)

(ii)

Shift of the demand curve.

A movement along the demand curve occurs when a change in the price of a
product leads to a change in the quantity demanded, as shown below:

A shift to the right in the demand curve arises when at every price consumers are
willing and able to buy more than they did before, as shown below:

Conversely a shift to the left would arise if consumers are able and willing to buy
less than they did before at each available price.
Shifts in the demand curve arise when the conditions of demand, as previously
discussed, change.

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THE SUPPLY CURVE

Supply refers to the quantity of a good that existing suppliers, or would be
suppliers, are willing and able to produce for the market at a given price.
The law of supply states that as prices rise, ceteris paribus, the quantity supplied
of the good will increase.
Graphical representation

Price $

Quantity (Units)

Market supply
The total quantity of a product that all producers, existing and potential, would
want to supply at each price.

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Determinants of supply (excluding price)

1.

Cost to produce

2.

Price of substitute goods

3.

Price of complements

4.

Technology

5.

Other factors

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Changes in supply
Understanding the effect of changing prices / conditions of supply on the supply
curve are key learning points for the exam.
A movement along the supply curve occurs following a change in the price of a
product which leads to a change in the quantity supplied, as shown below:

Extension

Contraction

Shifts in the supply curve arise when the conditions of supply change (other than
the price of the good itself!)
A reduction in the cost of supply will cause the supply curve to shift right, an
increase in the cost of supply will cause the supply curve to shift to the left.

Exercise 1
Move Along

Shift Left

Shift Right

Drought (no rain)

Fall in labour cost
Increase
wheat

price

of

Enhanced harvest
technology
Complete the above table to denote the impact on the supply curve for
wheat production as a result of the various events described?

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FORMATION OF EQUILIBRIUM PRICE

Market price is determined by the interaction of demand and supply.
equilibrium price being where demand equals supply.

The

Functions of the price mechanism

There are three functions of the price mechanism, as follows:
1.Signalling
2.Rationing
3.Rewarding

Discussion 2
Discuss the likely implications of price falling below P1 in the context of the three
functions of the price mechanism.
1.

Signalling;

2.

Rationing;

3.

Rewarding.

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DEMAND AND SUPPLY ANALSYSIS

In the exam you may be asked to consider the resulting impact on demand and
supply for substitute or complementary goods! Show the impact below on

Exercise 2
Fish and Chips

fish supplies fall as a result of overfishing.

Fish

Chips
S0

S0

D0

Coca-Cola and Pepsi

Coca-Cola through innovation reduce their production costs.

Coca-Cola

Pepsi
S0

D0

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D0

S0

D0

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