2.4 The interaction of demand and supply
- Syllabus
- 9708–2026–2027
- Topic
- 2.4
- Level
- AS
Learning objectives
2.4.1Market equilibrium• Definition of market equilibrium and disequilibrium2.4.2Demand/supply shifts and equilibrium• Effects of shifts in demand and supply curves on equilibrium price and quantity2.4.3Relationships between markets• Relationships between different markets:- joint demand (complements)- alternative demand (substitutes)- derived demand- joint supply2.4.4Price functions in allocation• Functions of price in resource allocation; rationing, signalling (transmission of preferences) and incentivising
Market equilibrium is where quantity demanded equals quantity supplied
Equilibrium occurs at the price and quantity where buyers’ quantity demanded equals sellers’ quantity supplied. A disequilibrium creates excess demand or excess supply.
If price is above equilibrium, a surplus puts downward pressure on price; if below, a shortage puts upward pressure, assuming prices can adjust.
At £5, buyers want 100 units and firms offer 100: equilibrium. At £3, demand may exceed supply, creating a shortage and pressure for price to rise.
Equilibrium does not mean the quantity is morally ideal or that nothing changes; it means the market-clearing condition at that moment.
How curve shifts change market equilibrium
| Single change, other curve fixed | Equilibrium price | Equilibrium quantity | Immediate disequilibrium pressure at the old price |
|---|---|---|---|
| Demand shifts right | Rises | Rises | Shortage |
| Demand shifts left | Falls | Falls | Surplus |
| Supply shifts right | Falls | Rises | Surplus |
| Supply shifts left | Rises | Falls | Shortage |
For each event: identify which curve shifts and direction, compare quantity demanded with quantity supplied at the old price, then follow price pressure to the new intersection. Elasticities affect the sizes of price and quantity changes, not the single-shift directions in the table.
With simultaneous shifts, treat each effect separately and combine only directions that agree. If demand and supply both fall, equilibrium quantity falls, but price is ambiguous because lower demand pushes it down while lower supply pushes it up; relative shift sizes and elasticities decide the result.
Do not report both outcomes as certain when the two shifts push one variable in opposite directions. State the unambiguous result and the condition needed to resolve the other.
Four relationships between markets
| Relationship | Definition | Transmission after an initiating change | Example |
|---|---|---|---|
| Joint demand | Goods are complements and used together | A rise in A's price reduces demand for B | Higher printer prices reduce demand for ink cartridges |
| Alternative demand | Goods are substitutes in consumption | A rise in A's price increases demand for B | Higher rail fares increase demand for coach travel |
| Derived demand | Demand for an input comes from demand for the output it helps produce | Higher demand for final output raises demand for the input | More construction raises demand for construction labour |
| Joint supply | Two products arise from the same production process, often as joint products or by-products | More production of A also increases supply of B | More cattle processing increases supplies of beef and hides |
Start with the named change, identify whether it changes demand or supply in the linked market, then trace equilibrium adjustment there. Keep the relationship direction explicit: substitutes and complements link demand; derived demand links an output market to an input; joint supply links outputs from one process.
Shared input costs can transmit supply shifts across markets, but that is not the syllabus definition of joint supply. Joint supply requires outputs produced together, not merely firms buying the same input.
How prices allocate resources
| Price function | What price does | Resource-allocation effect |
|---|---|---|
| Rationing | A higher price restricts effective demand when a good is scarce | Available output goes to buyers willing and able to pay |
| Signalling | Price changes transmit information about relative scarcity and consumer preferences | Firms and households reassess where resources or spending are valued |
| Incentivising | Expected higher returns encourage supply; higher costs discourage demand | Producers move resources toward profitable uses and consumers economise or switch |
If electricity becomes scarce, a higher price can ration current use, signal that supply is tight relative to demand, encourage households to conserve and attract producers to expand generation. The same price movement therefore performs all three functions through different channels.
The mechanism works better when participants receive reliable information, prices can adjust, entry and switching are possible, and external costs or benefits are reflected. Taxes and subsidies can alter relative prices and therefore incentives.
Market rationing is based on willingness and ability to pay, so it need not be equitable. A price signal also does not guarantee complete knowledge or the physical ability to respond.