Chapter 10

Price changes
 Learning objectives
• By the end of this chapter you will be able to:
explain how changes In market conditions
cause price changes
use demand and supply diagrams to illustrate
changes in market conditions and the
consequences for equilibrium price and sales
10.1 The effect of changes in demand

Price changes when the market conditions of

demand and supply change. Changes in
demand will cause a change in price and a
movement along the supply curve. Figure 10.1
shows the effect of an increase in demand.
Initially there is a shortage of xy This shortage
forces the price to move up
The effect of an increase in demand
 The effect of a decrease in demand

• The higher price encourages an extension in supply until

a new equilibrium price of P1 is reached At this price,
demand and supply are again equal In contrast. a
decrease in demand will cause a fall in price and a
contraction in supply Figure 10.2 shows demand
decreasing from DD to D1D1. With lower demand, there
will be a surplus of unsold products at the initial price of
P. This surplus pushes down the price As a result. supply
contracts until the new equilibrium price of P1 and a
new quantity of Q1 are reached.
The effect of a decrease in demand
Answer Individual Activity 1
Answer Individual Activity 1
10.2 The effect of changes in supply

Changes in supply cause a change in price and

a movement along the demand curve Initially,
an increase in supply will cause a surplus This
surplus will drive down the price and result in
an extension in demand, as shown in Figure
10.3.
The effect of an increase in supply
 The effect of a decrease in supply

• A decrease in supply will have the opposite

effect. It will cause a rise in price, which in
turn causes a contraction in demand, as
shown in Figure 10.4.
The effect of a decrease in supply
 TIP
When questions ask about the effect on the
market of a product. make sure you cover
demand, supply and price. Also, be careful to
get the order of events right For example, an
increase in demand will first cause a rise in
price and then an extension in supply.
Answer Individual Activity 2
Answer Individual Activity 2
Answer Individual Activity 2
Answer Individual Activity 2
Answer Individual Activity 2
 10.3 Changes in demand and supply

• It is, of course, possible for both the

conditions of demand and the conditions of
supply to change at the same time. In this
case. the impact on the market will depend
not only on the direction of the changes. but
also on the size of the changes.
 Example
A report may come out stating that eating apples is
good for people’s health and. at the same time, that
good weather contributes to a record harvest. In this
case. both demand and supply will increase, This will
result in an increase in the quantity being bought and
sold. The effect on price, however. will depend on
relative strengths of shifts in demand and supply.
Figure 10.5 shows the increase in demand being
greater than the increase in supply. As a result, price
rises .
The effect of demand increasing more than supply
 The effect of supply increasing more than demand

• In contrast. Figure 10.6 shows the increase in

supply exceeding the increase in demand,
causing price to fall.
 Answer Group Activity 1
1 The price of agricultural products fluctuates more than
the price of manufactured goods because agricultural
products are affected by weather conditions, pests and
diseases and because manufactured goods can be stored.
A period of bad weather or the outbreak of a disease could
cause a significant decrease in the supply of, for instance,
wheat. Wheat is also perishable. If there is a bumper crop,
it will all have to be sold. A large increase in supply could
result in a significant fall in price. In contrast, producers of
shoes do not have to sell all the shoes they produce if they
think it will lead to a fall in price.
Answer individual Activity 3
 Answer individual Activity 3
• The slaughter of chicken will reduce the supply
of chicken. Also, the disease is likely to
discourage the consumption of chicken and
hence demand will decrease. These changes
will cause the quantity bought and sold to fall.
The effect on price will depend on the relative
size of the two shifts. Price may rise, fall or if (as
in the diagram) supply and demand decrease
by an equal amount, remain unchanged.
 Multiple choice questions

The diagram shows a change in the market for

coffee. What could explain this change?
• A A rise in the price of coffee
B A rise in the price of tea
C A successful advertising campaign for tea
D A health report indicating that drinking
coffee can cause headaches
 Multiple choice questions

2 The diagram shows the demand for and

supply of a product. The initial equilibrium is
at point x. The cost of raw materials used to
produce me product falls Which point
represents me new equilibrium
 Multiple choice questions

3 Which diagram best illustrates the effect of an

increase in income on the market for an
inferior good?
 Multiple choice questions

4 What effect would a decrease in supply of a

product have on its price and demand?
Price Demand
A decreases contracts
B decreases extends
C increases contracts
D increases extends
 Answer
• 1 B The diagram shows an increasing demand
for coffee. A rise in the price of tea may cause
some people to switch from drinking tea to
drinking coffee. A rise in the price of coffee
here is the consequence of demand and not
the cause. C and D would be likely to cause a
decrease in demand for coffee.
• 2 C A reduction in the cost of raw materials
would cause an increase in supply.
 Answer
• 3 B An inferior good has an inverse
relationship with income. As income rises,
demand decreases. As people get richer, they
buy more of high-quality products and less of
low-quality products.
• 4 C A decrease in supply would raise price and
cause demand to contract.
 Four-part question
A Identify two causes, apart from an in crease in
income, of an increase in demand for a product. (2)
B Explain why an increase in wages is likely to increase
demand but may reduce supply. (4)
C Analyse, using a demand and supply diagram, the
granting of a subsidy to me producers of a product. (6)
D Discuss whether or not the price of air travel is likely
to rise in the future. (8)
 Answer
• a For example: a successful advertising campaign
and an increase in the price of a substitute.
• b An increase in wages will increase demand for
normal goods. This is because people will have a
greater ability to buy products – their purchasing
power has increased. Supply, however, may
decrease. This is because higher wages will
increase costs of production, if productivity does
not increase in line with the higher wages.
• The granting of a subsidy is designed to
encourage producers to supply more. It is
likely to increase supply. The higher supply will
lower price and the lower price will cause
demand to extend as shown on the diagram
below.
• d The price of air travel may increase in the future.
Population increases will increase the number of
potential passengers. Air travel is used by business
passengers and by tourists. An increase in income would
be likely to be accompanied by an increase in business
activity and so there would be more business
passengers. Air travel is a complement to foreign
holidays, which are a normal good. As people get richer,
they are likely to take more foreign holidays and to
travel further. Airlines may also decide to spend more on
advertising, which may stimulate higher demand.
• Other forms of transport are a substitute for
air travel and so demand for air travel will be
affected by changes in the price and quality of
these forms of transport. For example, if train
travel rises in price, some people may switch
to air travel for some journeys. A fall in the
quality of sea travel may also encourage an
increase in demand for air travel.
• As well as increases in demand pushing up
price, a decrease in supply may result in a
higher price of air travel. For instance, the cost
of fuel may increase, which would reduce
supply and raise price.
• There are, however, reasons for thinking that the price
of air travel may fall in the future. Some governments
subsidise their countries’ airlines and they may
increase the subsidies they give. Air travel is a very
safe method of transport but a major crash may
discourage some people from flying. A significant
reason why the price may fall is advances in
technology. Planes are becoming more fuel-efficient
and there are a number of larger planes being
developed. In recent years, the relative price of air
travel has fallen.