Demand, Supply and Market Equilibrium
Senior 4 · Economics
Demand, Supply and Market Equilibrium
Lesson 1 of 3
18 min
Late in the afternoon at Kimironko market in Kigali, a trader still has two crates of tomatoes she does not want to carry home. She drops the price from 700 Frw a heap to 400 Frw, and within twenty minutes the crates are empty. She did not advertise, and the tomatoes did not improve. Only the price changed, and buyers who had walked past at 700 came back at 400.
That everyday scene is the whole of this lesson in miniature. If you can say precisely why the lower price pulled in more buyers, and separate that from the reasons a whole market of buyers might want more tomatoes than before, you can predict how any market will react to a price change or a policy. Demand is the buyers' side of every market, and equilibrium (the next lessons) is impossible to analyse until you have it exactly right.
In ordinary speech "demand" means wanting something. In economics it means more, and the extra words carry weight. Demand is the quantity of a good that consumers are both willing and able to buy at a given price, over a given period, all other things held constant.
Three parts matter. Willing and able: wanting a car you cannot pay for is not demand; only backed-up-by-money wanting (called effective demand) counts. Over a given period: 300 eggs is meaningless until you say per day or per week. All other things held constant: economists change one thing at a time and freeze the rest, a habit written in Latin as ceteris paribus — "other things being equal." You will meet that phrase in every rule below, and it is the reason the rules stay clean.
Suppose a survey at a market records how many eggs buyers would take each day at several prices. The result is a demand schedule — a table of price against quantity demanded (Qd):
| Price per egg (Frw) | Quantity demanded (eggs/day) |
|---|---|
| 50 | 500 |
| 100 | 400 |
| 150 | 300 |
| 200 | 200 |
| 250 | 100 |
Look down the table: every time the price climbs by 50 Frw, the quantity demanded drops by 100 eggs. The relationship is exact enough to write as a formula. If P is the price, the pattern is
Qd = 600 − 2P
Check one row to be sure: at P = 150, Qd = 600 − 2(150) = 600 − 300 = 300 eggs, which matches the table. This single equation reproduces every row, and you will use it again when you find the market's equilibrium.
The table shows the law of demand: other things being equal, when the price of a good rises the quantity demanded falls, and when the price falls the quantity demanded rises. Price and quantity move in opposite directions — an inverse relationship.
Plot the schedule with price on the vertical axis and quantity on the horizontal axis, join the points, and you get the demand curve. Because price and quantity move in opposite directions, the curve slopes downward from left to right. That downward slope is not a convention; it is the law of demand drawn as a picture.
It is not enough to state the law. At A-Level you should be able to say why lowering the price genuinely raises quantity demanded, and there are two separate forces.
The substitution effect. When the price of eggs falls, eggs become cheaper relative to other sources of protein such as beans or milk. Some buyers switch toward the now-relatively-cheaper eggs. Their quantity demanded rises even though their income has not changed.
The income effect. When the price of eggs falls, a buyer's given amount of money — their real income, meaning what the money can actually buy — stretches further. With the same 1,000 Frw they can now afford more eggs than before, so quantity demanded rises. These two effects push in the same direction and together guarantee the downward slope for an ordinary (normal) good.
This is the distinction A-Level examiners test most, and the one students most often get wrong. Hold it firmly.
A movement along the demand curve happens when, and only when, the good's own price changes. Nothing else has moved, so you slide from one point on the same curve to another point on that same curve. A fall in own price gives a downward movement to a larger quantity — called an extension (or expansion) of demand. A rise in own price gives an upward movement to a smaller quantity — a contraction of demand.
A shift of the whole demand curve happens when something other than the good's own price changes — one of the determinants below. The entire curve moves to a new position: to the right if more is now demanded at every price (an increase in demand), to the left if less is demanded at every price (a decrease in demand).
Consider the market for bananas and classify each change.
(a) The price of bananas falls from 300 Frw to 200 Frw a bunch; nothing else changes. The good's own price changed, so this is a movement along the curve — specifically a downward movement, an extension of demand, to a larger quantity.
(b) During harvest season household incomes rise, and bananas are a normal good; the price of bananas has not changed. Income is not the good's own price, so the whole curve shifts to the right: at every price, more bananas are now demanded. This is an increase in demand.
The test is mechanical and reliable: if the good's own price is what changed, it is a movement; if anything else changed, it is a shift.
Any of these non-price factors can shift the demand curve. Learn them as a checklist.
Tip
Exam technique — the one question to ask first. Before you draw anything, ask: did the good's own price change, or did something else change?
Losing this distinction is the single most expensive error in demand-and-supply questions, because the rest of your diagram is then built in the wrong place.
Work each one on paper before reading the solution.
A demand schedule is Qd = 120 − 3P. Find Qd when P = 20 and when P = 30, and describe the change in words.
For the market for beef, state whether each change causes a movement along the demand curve or a shift of it, and in which direction: (i) the price of beef rises; (ii) a health scare turns people away from red meat; (iii) incomes rise and beef is a normal good.
Rice and maize flour are substitutes. The price of rice falls. What happens to the demand for maize flour, and why?
Cars and petrol are complements. The price of petrol rises sharply. What happens to the demand for cars, and why?
At P = 20: Qd = 120 − 3(20) = 120 − 60 = 60. At P = 30: Qd = 120 − 3(30) = 120 − 90 = 30. As the price rose from 20 to 30, the quantity demanded fell from 60 to 30. Because the good's own price changed, this is a movement up along the demand curve — a contraction of demand. (It also shows the law of demand: price up, quantity down.)
(i) The good's own price changed, so a movement up the curve — a contraction. (ii) Tastes changed, so a shift left (decrease in demand). (iii) Income changed and beef is normal, so a shift right (increase in demand). Notice only (i) is a movement; the other two are shifts.
Rice is now cheaper, so some buyers switch from maize flour toward rice. Fewer people want maize flour at every price, so the demand curve for maize flour shifts left (a decrease in demand). The trigger was the price of a related good, not the price of maize flour itself, so it must be a shift, not a movement.
Petrol and cars are used together, so dearer petrol makes owning a car more expensive overall. Fewer people want cars at every price, so the demand for cars shifts left. Again the trigger is a related good's price, giving a shift.
Summary — what to remember
