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Demand, Supply, Elasticity | 4.1.3 | AQA A-Level Economics Notes

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4.1.3.1 The Determinants of the Demand for Goods and Services

  • Demand is the quantity of a good or service that consumers are willing and able to buy at a given price in a given period of time.
  • A demand curve shows the inverse relationship between price and quantity demanded. (As prices fall, goods become more affordable and so demand is higher). Price changes cause contractions/ expansions in demand.
  • The demand curve can also shift to the left or right due to its factors (PIRATES): population, income, related goods, advertising, tastes and fashions, expectations (price etc), season.

4.1.3.2 Price, Income and Cross Elasticities of Demand

  • PED – the degree of responsiveness of quantity demand following an initial change in price.
  • (SANDPIT) factors can affect PED: substitute goods, addictiveness, necessity, durability, proportion of income spent on good, time.
  • Total revenue is price times by quantity sold. If PED is inelastic, firms can raise prices without affecting demand much, leading to an increase in revenue. If PED is elastic, raising prices often lead to a fall in total revenue.
  • YED – the degree of responsiveness of quantity demanded following an initial change in income.
  • Inferior goods have a negative YED, normal goods have a positive YED and luxury goods have a YED which is higher than one (very elastic).
  • XED – the degree of responsiveness of the demand of a good X, following a change in the price of a different good Y.
  • Complementary goods have a negative XED (if one good becomes too expensive, the demand for both goods falls).
  • Substitute goods have a positive XED.
  • Unrelated goods have an XED of zero.
  • XED shows firms how many competitors they have, and how likely it is that they will be affected by another firm’s price changes.

4.1.3.3 The Determinants of the Supply of Goods and Services

  • Supply is the quantity of goods and services that a producer is willing and able to supply at a given price level, in a given period of time.
  • Price and supply have a direct relationship. If prices increase, firms supply more due to the profit motive for both existing firms and new entrants.
  • Movements along the curve show expansion/ contraction and they are caused by price changes.
  • Shifts can be caused by (PCTWINS): productivity, costs of production, technology, weather, indirect taxation, number of firms, subsidies.
  • Under perfect competition, the supply curve is the marginal cost curve.

4.1.3.4 Price Elasticity of Supply

  • PES – the degree of responsiveness of quantity supplied following an initial change in price.
  • Factors (SECTS): substitutability of factors, entry barriers, spare capacity, time, level of stocks.

4.1.3.5 The Determination of Equilibrium Market Prices

  • Equilibrium price and quantity is where demand meets supply. At this quantity, price has no tendency to change. It is the market-clearing price.
  • When demand is not equal to supply, we have disequilibrium.
  • When demand is more than supply, there is excess demand. There is a shortage of supply causing prices to push up to ration supply. This causes demand to contract, to create a new, higher equilibrium price.
  • When supply is higher than demand, there is excess supply. This causes firms to lower prices to sell their goods. When supply clears, the market returns to equilibrium.
  • The model of demand and supply assumes that prices change instantly when there is a shift in demand or supply, but in reality there is disequilibrium before firms react to quantity changes.

4.1.3.6 The interrelationship between Markets

  • Changes in particular markets are likely to affect other markets.
  • Joint demand is when two goods are demanded together (e.g. cameras and memory cards).
  • Substitute goods are in competitive demand and act as replacements for each other.
  • Composite demand is when the good produced has one or more composite uses (e.g. milk used for cheese and butter).
  • Derived demand is when the demand for one good is related to the demand for another good as they are needed in each other’s production (e.g. bricks and houses).
  • Joint supply is when increasing the supply of one good causes a change in supply of another good (e.g. supplying more lamb and wool at the same time).