Unit 2.4 - Interaction of demand and supply

• Market equilibrium


  A situation where demand equals supply, and there is no tendency to change. The price mechanism ensures that the market "clears"
• Market disequilibrium


  A situation where demand and supply are not equal, resulting in excess demand or supply. The market mechanism will adjust demand or supply to reach equilibrium.
• Effects of shifts on equilibrium

  Equilibrium price and quantity changes when there are non-price changes to demand and supply
• Causes of a shift in demand curve

  • Income / ability to pay
  • Price / availability of substitutes & complements
  • Fashion, tastes and attitude
• Causes of a shift in supply curve

  • Costs associated with supplying the product
  • Changes in the prices of other products
  • Size and nature of the industry
  • Government policy
• A change in supply and demand
• Alternative demand


  A substitute product. A rise in price for the one product due to decrease in supply will cause an increase in demand and price for the substitute product
• Joint demand


  A complement is in joint demand. An increase in supply will see the price of one product fall prompting and increase in demand for the compliment
• Derived demand


  The demand for a good or service that results from the demand for a different, or related good or service / factor of production
• Joint supply


  A product or process that can yield two or more outputs
• Functions of price mechanism in resource allocation

  • Rationing
  • Signaling and transmission of preferences
  • The provision of incentive
• Rationing


  Limits products in the market e.g. due to exclusivity
• Signaling and transmission of preferences


  Acts as a signal to consumers and suppliers. Rise in QD causes a rise in price, signalling to producers to supply more and vice versa. Also allows the wants of consumers to be made known.
• The provision of incentive


  Low prices and special offers encourage consumers to buy more - higher satisfaction (utility). High prices also encourage firms to supply more goods.