2.4 The interaction of demand and supply

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.

A demand or supply shift changes the intersection of the curves. A rightward demand shift usually raises equilibrium price and quantity; a rightward supply shift usually lowers price and raises quantity, with the exact outcome depending on elasticities.

Draw the original and new curves, identify the new intersection, then explain the movement through shortage or surplus pressure.

A harvest failure shifts supply left, tending to raise food price and reduce quantity; a successful advertising campaign shifts demand right, tending to raise both.

Do not assume every demand shift raises quantity: a leftward shift lowers it, and simultaneous shifts can produce ambiguous outcomes.

A change in one market can affect another when goods are substitutes or complements, when firms share inputs, or when income and expectations transmit effects across markets.

Trace the direction: a price rise for a substitute can shift demand for the other good right; a price rise for a complement can shift it left; a shared input-cost increase can shift several supplies left.

A rise in petrol prices may reduce demand for large cars but increase demand for rail travel, while raising costs for delivery services.

Markets are not linked merely because products are both “consumer goods”; a specific relationship or shared constraint must be identified.

A price rations by limiting access when demand exceeds supply, signals information about scarcity and preferences, and incentivises consumers and producers to change behaviour.

The same price can perform all three functions, though distributional effects may make market rationing unequal. Taxes and subsidies alter incentives by changing relative prices.

A higher electricity price signals scarce supply, rations consumption and encourages households to insulate while attracting investment in generation.

A price signal is not a guarantee that every market participant receives complete information or can afford the good.