Own price
The price of the product affects how much a consumer chooses to buy.
Cambridge International AS Level Economics · 9708 · Chapter 2
Demand and supply curves
The demand and supply model explains how buyers and sellers behave in markets. This chapter develops individual and market demand and supply, the factors that change them, and the crucial distinction between moving along a curve and shifting the whole curve.
Book-aligned notesClear worked examplesExplained figures
What this chapter prepares you to do
You should be able to define demand and supply precisely, identify their determinants, draw and interpret demand and supply curves, and explain whether a change causes a movement along a curve or a shift of the curve.
High-grade habit: always identify the market first, then state the cause, show the correct movement or shift on the diagram, and explain the result. Do not say “demand changed” when only quantity demanded changed because of the good’s own price.
Chapter sections
2.1
Demand
Effective demand
Effective demandThe quantity of a good or service that consumers are willing and able to buy, given its price, the prices of other goods, and consumers’ incomes and preferences.
Wanting a product is not enough to create effective demand. A consumer must also have the ability to pay. This links demand back to scarcity: income is limited, so consumers have to choose between alternative purchases.
Income
Income limits purchasing power and can change the quantity consumers want at each price.
Prices of other goods
Related products can make the good more or less attractive.
Preferences
Tastes, advertising, fashion and expectations can influence willingness to buy.
Individual and market demand
Individual demand
The quantity one consumer is willing and able to buy at different prices.
Market demand
The total quantity all potential buyers in the market are willing and able to buy at each price.
Market demand reflects the same influences as individual demand, but it is also affected by the number of potential buyers. If more consumers enter a market, total market demand is likely to increase.
Exam precision: demand means willingness and ability to buy. A person who wants a new phone but cannot afford it does not create effective demand for that phone at the current price.
2.2
Supply
Firms and the supply decision
FirmAn organisation or business that combines factors of production in order to produce output.
Supply analysis focuses on sellers. Firms decide how much output they are prepared and able to offer to the market. For the basic model, economists commonly assume that firms aim to maximise profit, where profit is the difference between total revenue and total cost.
Sole proprietor
A business owned and run by one owner.
Partnership
A business in which ownership, profits and liabilities are shared between partners.
Joint-stock company
A company owned by shareholders. Shares in a public company are traded on a stock exchange, unlike those of a private company.
Individual and market supply
Individual supply
The quantity of a good or service that one firm is prepared and able to sell at a given price.
Market supply
The total quantity supplied by all firms operating in the market at each price.
Because market supply adds together the supplies of all firms, the number of firms in the market is an important influence on total supply.
2.3
Determinants of demand
Price and the law of demand
Law of demandCeteris paribus, there is an inverse relationship between the price of a good or service and its quantity demanded.
If all other influences remain unchanged, a lower price is expected to increase quantity demanded and a higher price is expected to reduce quantity demanded. This relationship is shown by a downward-sloping demand curve.
A demand curve for smartphones
The downward-sloping curve shows the law of demand: ceteris paribus, a lower price is associated with a greater quantity demanded and a higher price with a smaller quantity demanded. A change in the smartphone’s own price causes a movement along this curve, not a shift of the curve.
Adapted from Cambridge International AS & A Level Economics, Second Edition, by Peter Smith (with Adam Wilby and Mila Zasheva).
How to read a demand curve: Choose a price on the vertical axis, move horizontally to the demand curve, then move down to the quantity axis. The book emphasises that the curve records the quantity consumers are willing and able to buy at each possible price, while other demand influences are held constant.
Relative price: the price on the vertical axis is interpreted while other prices are held constant. This is one use of the ceteris paribus assumption.
Why the demand curve slopes downwards
Income effect
A price rise reduces the consumer’s real purchasing power, leaving less income available after buying the good.
Substitution effect
A price rise makes alternatives relatively more attractive, encouraging consumers to switch away from the good.
These effects help explain the usual inverse price–quantity relationship.
Consumer income: normal and inferior goods
| Type | When consumer income rises | Demand curve | Illustrative example |
|---|---|---|---|
| Normal good | Demand increases. | Shifts right. | Foreign holidays. |
| Inferior good | Demand decreases. | Shifts left. | Bus travel may fall as more consumers can afford cars or taxis. |
Normal goodA good for which quantity demanded rises when consumer income rises.
Inferior goodA good for which quantity demanded falls when consumer income rises.
A shift in the demand curve following an increase in consumer incomes (a normal good)
Foreign holidays are used as an example of a normal good. When consumer incomes rise, demand is higher at every price, so the whole demand curve shifts to the right from D₀ to D₁.
Adapted from Cambridge International AS & A Level Economics, Second Edition, by Peter Smith (with Adam Wilby and Mila Zasheva).
A shift in the demand curve following an increase in consumer incomes (an inferior good)
Bus journeys are used as an example of an inferior good. As incomes rise, some consumers may switch to cars or taxis, so fewer bus journeys are demanded at each price and the demand curve shifts left from D₀ to D₁.
Adapted from Cambridge International AS & A Level Economics, Second Edition, by Peter Smith (with Adam Wilby and Mila Zasheva).
The price of related goods
| Relationship | Meaning | Example | Effect of a price rise in Good A on demand for Good B |
|---|---|---|---|
| Substitutes | Consumers see the goods as alternatives. | Tea and coffee. | Demand for the substitute Good B rises. |
| Complements | The goods tend to be consumed together. | Cars and petrol; cereal and milk. | Demand for the complement Good B falls. |
A shift in the demand curve following an increase in the price of a substitute good
Tea and coffee are substitutes in this example. When the price of tea rises, consumers move along the tea demand curve and some switch to coffee, increasing demand for coffee and shifting the coffee demand curve to the right.
Adapted from Cambridge International AS & A Level Economics, Second Edition, by Peter Smith (with Adam Wilby and Mila Zasheva).
A shift in the demand curve following an increase in the price of a complementary good
Tea and milk are complements in this example. A rise in the price of tea reduces the quantity of tea demanded; because the two goods are consumed together, demand for milk also falls and the milk demand curve shifts to the left.
Adapted from Cambridge International AS & A Level Economics, Second Edition, by Peter Smith (with Adam Wilby and Mila Zasheva).
Preferences, advertising, fashion and expectations
Many other influences can be grouped under consumer preferences. Advertising may make a product more attractive, fashion can create sudden rises or falls in popularity, and consumers may be influenced by what other people buy.
Expectations can also matter. If buyers expect the price of an asset or durable good to rise, they may purchase earlier. If they expect a hi-tech product to become cheaper, they may delay buying it.
Extension ideas: snob effects and Giffen goods
Snob / conspicuous consumption effect
Some individuals may value an expensive product partly because its high price signals status. This can weaken the normal response to price for those buyers, although the chapter notes no evidence of whole markets generally showing upward-sloping demand for this reason.
Giffen good
A theoretical case in which a very strong income effect for an inferior good could outweigh the substitution effect, so quantity demanded rises when price rises. The chapter presents this as a theoretical possibility rather than an established market pattern.
Do not mix up a movement and a shift: a change in the good’s own price causes movement along demand. Income, related-good prices, preferences, expectations and the number of buyers shift the curve.
2.4
Determinants of supply
Price and the supply curve
Supply curveA graph showing the quantity that firms are prepared and able to supply at each price.
In a competitive market, firms are generally expected to offer more output at a higher selling price, ceteris paribus, because the opportunity to earn profit is greater. The basic supply curve therefore slopes upwards from left to right.
A supply curve
The upward-sloping curve shows that firms in a competitive market are generally prepared to supply more at a higher price, ceteris paribus. A change in the product’s own price causes an extension or contraction of supply along the same curve.
Adapted from Cambridge International AS & A Level Economics, Second Edition, by Peter Smith (with Adam Wilby and Mila Zasheva).
Price is not cost: price is what the buyer pays for the product. Cost is what the firm pays to produce it.
Six important influences on market supply
1. Production costs
Higher input costs reduce the quantity firms are willing to supply at each selling price, shifting supply left.
2. Technology
More cost-effective production can reduce costs and shift supply right.
3. Taxes & subsidies
A sales tax raises firms’ effective costs and shifts supply left; a subsidy lowers costs and shifts supply right.
4. Prices of related goods
Firms may switch resources towards products that become more profitable, or jointly supply related products.
5. Expected future prices
Producers may alter current supply if they expect future prices to change, especially for storable goods or products with long production lags.
6. Number of firms
Entry of firms increases market supply; firms leaving the market reduce it.
Costs and technology
If the prices of inputs such as labour, capital or raw materials increase, profit at each selling price is reduced. Firms therefore tend to supply less at every price. A technology improvement that lowers unit costs has the opposite effect.
The supply curve shifts to the left if production costs increase
Higher production costs reduce the quantity firms are willing to supply at every selling price. In the book’s example, at a price of $10 the quantity supplied falls from 100 to 50 units after costs rise by $6 per unit.
Adapted from Cambridge International AS & A Level Economics, Second Edition, by Peter Smith (with Adam Wilby and Mila Zasheva).
The supply curve shifts to the right if new technology lowers production costs
A cost-saving technology allows firms to supply more at every price. In the book’s example, a $6 fall in unit cost means that at a price of $10 quantity supplied can rise from 50 to 100 units.
Adapted from Cambridge International AS & A Level Economics, Second Edition, by Peter Smith (with Adam Wilby and Mila Zasheva).
Taxes and subsidies
The effects of taxes and subsidies on supply
A per-unit sales tax raises the effective cost of supplying the product and shifts the supply curve left/up. A subsidy reduces the effective cost and shifts supply right/down. The vertical distance between the parallel curves represents the per-unit tax or subsidy.
Adapted from Cambridge International AS & A Level Economics, Second Edition, by Peter Smith (with Adam Wilby and Mila Zasheva).
Related goods in supply
A firm may be able to use the same resources for alternative products. If the price and profitability of onions rise relative to sweet potatoes, for example, a farmer may switch land towards onions, reducing the supply of sweet potatoes.
Some goods are produced jointly. If producing more of one good automatically creates more of a by-product, a rise in the profitability of the main product may increase the supply of both.
Expected prices and production time
Supply decisions often look forward because production takes time. A producer may hold back a storable product if a higher future price is expected. For long-production-period goods, expectations are even more important: the book uses palm oil, rubber and mangoes as examples because newly planted trees take several years to mature before they produce output.
Quantitative diagram point: when a per-unit cost changes by a fixed amount, the vertical distance between the original and shifted supply curves can represent that change in unit cost.
2.5
Movements along and shifts of demand or supply
This distinction is one of the most important diagram skills in AS Economics. The curve itself already shows how quantity responds to the product’s own price. Therefore a change in own price moves the economy to another point on the same curve. A change in another determinant changes the relationship and shifts the whole curve.
| Curve | Cause | Correct term | What happens? |
|---|---|---|---|
| Demand | Price falls | Extension of demand | Movement down/right along the demand curve. |
| Demand | Price rises | Contraction of demand | Movement up/left along the demand curve. |
| Demand | Non-price determinant raises demand | Increase in demand | Demand curve shifts right. |
| Demand | Non-price determinant lowers demand | Decrease in demand | Demand curve shifts left. |
| Supply | Price rises | Extension of supply | Movement up/right along the supply curve. |
| Supply | Price falls | Contraction of supply | Movement down/left along the supply curve. |
| Supply | Non-price determinant raises supply | Increase in supply | Supply curve shifts right. |
| Supply | Non-price determinant lowers supply | Decrease in supply | Supply curve shifts left. |
Book example: shift versus movement: If something other than the product’s own price changes, such as tastes, the demand curve for Xbox games can shift. If instead the price of Xbox games falls, there is an extension of demand along the existing curve. The same distinction applies to supply: own-price changes cause movements; other supply determinants cause shifts.
A reliable exam method
1. Identify the marketWhich good or service is the diagram about?
→2. Identify the causeOwn price or another determinant?
→3. Name the changeExtension/contraction or increase/decrease?
Example 1: the price of ice cream rises. This is the product’s own price, so there is an extension of supply along the existing supply curve — not a shift.
Example 2: a new production process lowers the cost of making bicycles. Cost is a non-price determinant of supply, so the supply curve shifts right.
Example 3: the price of tea rises and coffee is a substitute. The demand for coffee increases, shifting the coffee demand curve right.
Example 4: real incomes rise and bus journeys are inferior. Demand for bus journeys decreases, shifting the demand curve left.
Language matters: Cambridge-style answers are clearer when “extension” and “contraction” are reserved for movements along a curve, while “increase” and “decrease” describe shifts.
Chapter 2 revision checklist
Define effective demand using willingness and ability to buy.
Distinguish individual from market demand.
Define individual and market supply.
Explain why firms are assumed to respond to profit incentives.
State and apply the law of demand.
Draw and interpret a demand curve correctly.
Explain income and substitution effects.
Distinguish normal and inferior goods.
Distinguish substitutes from complements.
Explain how preferences, advertising and expectations affect demand.
Recognise snob effects and Giffen goods as extension ideas.
Draw and interpret an upward-sloping supply curve.
Explain how production costs affect supply.
Explain how technology affects supply.
Explain the supply effects of taxes and subsidies.
Explain related goods and joint supply.
Explain expected prices and the number of firms as supply determinants.
Distinguish movement along a demand curve from a shift.
Distinguish movement along a supply curve from a shift.
Use extension, contraction, increase and decrease accurately.
18 questions. Each answer is marked immediately with a short explanation of why it is correct or incorrect.