- A market occurs where buyers and sellers meet to exchange money for goods.
- The Price Mechanism refers to how Supply and Demand interact to set the market price and amount of goods sold
- At most prices planned demand does not equal planned supply therefore
equilibrium will occur where Supply meets demand.
- If price was below the equilibrium at P2 then demand would be greater than the supply. Therefore there is a shortage of (Q2 – Q1)
- Therefore firms will put up prices and supply more. As price rises there will be a movement along the demand curve and less will be demanded.
- Therefore price will rise to Pe until there is no shortage and Supply = Demand
What would happen if Price was Above the Equilibrium?
If price was above the equilibrium then Supply would be greater than demand and therefore there is too much supply. There is a surplus.
Therefore firms would reduce price and supply less. This would encourage more demand and therefore the surplus will be eliminated.
Movements to a new Equilibrium
If there was an increase in income the demand curve would shift to the right. Initially there would be a shortage of the good, therefore the price and Quantity supplied will increase leading to a new equilibrium at Q2
Graph increase in Demand
An increase in supply would lead to a lower price and more quantity sold.
Essay Questions on Supply and Demand
Q. Explain factors that could explain a fall in the price coffee
The price of coffee would fall if there was a fall in demand and/ or an increase in supply
The demand for coffee could fall for various reasons such as
i) lower incomes mean that consumers cannot afford to buy as much
ii) Less fashionable
iii) Decrease in the price of substitutes such as tea
The supply of coffee could increase for various reasons such as:
i) Increase in the number of suppliers
ii) Lower costs of production
iii) Govt subsidies
iv) Higher labour productivity in producing coffee, this will decrease the costs of production
Blog Post: The Economics of The Price of Coffee
More Essay Questions
1. With the Aid of Supply and Demand diagrams explain the effect on the market for mobile phones if:
a) Improved technology producing mobile phones
b) Increase in the number of suppliers but lower incomes caused by lower wages
c) An increase in taxes on mobile phones but an increase in advertising for phones with new features
2. What could cause the price of aluminium to increase? (use a diagram and consider both supply and demand side factors)
3. What could explain a fall in the price of computers?
4. Examine why there has been a fall in demand for red meat?