Changes in price cause signals in the market mechanism.
For example, if there is an increase in demand this will lead to a higher price, and a movement along the supply curve.
· However in the long run High Prices act as an incentive for firms to supply more.
· Therefore firms will expand their production or new firms enter in the market. This will cause the supply curve to shift to the right.
· For example with an increase in demand for mobile firms more firms entered the market. Therefore prices have not increase but stayed roughly the same.
When the oil price tripled in the 1970s this encouraged new countries to start producing oil, e.g. it was now profitable for the UK to produce.
The Effect of an increase in Costs.
If a good becomes more expensive to produce, supply will shift to the left and there will be a movement along the demand curve leading to lower demand.
There will be an increase in demand for substitutes, for example if wool becomes more expensive then there will be an increase in demand for nylon.
· In the short term there may be not many substitutes, therefore demand is quite inelastic, and demand only falls a little.
· However in the long run firms may develop alternatives so consumers have more alternatives. Therefore over time demand will be more elastic and fall by more,
For example if petrol became more expensive then in the short run demand would not fall very much. However, over time firms would develop more alternative such as electricity cars or solar powdered