Changing Market Conditions (Cambridge (CIE) O Level Economics)
Revision Note
Causes and Consequences of Price Changes
Real world markets are constantly changing and are referred to as dynamic markets
Market equilibrium can change every few minutes in some markets (e.g. stocks and shares), or every few weeks or months in others (e.g Clothing)
Any change to a condition of demand or supply will temporarily create disequilibrium and market forces will then seek to clear the excess demand or supply
Real world example: changes to demand that increase price
During lock downs associated with the Covid-19 pandemic, furniture retailers experienced unexpectedly high demand for their products (especially desks and sofas)
Diagram analysis
Due to the Covid mandated change of working from home, consumers experienced a temporary change in taste as they sought to set up comfortable home offices
This led to an increase in demand for desks from D1→D2
At the original market clearing price of P1, a condition of excess demand now exists
The demand for desks is greater than the supply
In response, suppliers raise prices
This causes a contraction of demand and an extension of supply leading to a new market equilibrium at P2Q2
Both the equilibrium price (P2) and the equilibrium quantity (Q2) are higher than before
The excess demand in the market has been cleared
Examiner Tip
Be systematic in thinking through the order of changes in market conditions. e.g. an increase in demand (shift in demand) will cause a rise in price. The higher price will cause an extension of supply (not a shift of supply)
Real world example: changes to supply that increase price
In September 2022, Hurricane Fiona destroyed much of Puerto Rico's crop of plantains (a necessity in the diet of local people)
Diagram analysis
Due to Hurricane Fiona, Puerto Rico is experiencing a supply shock in its plantain market
This causes a decrease in supply of S1→S2
At the original market clearing price of P1, a condition of excess demand now exists (shortage)
The demand for plantain is greater than the supply
In response, sellers in Puerto Rico raise prices
This causes a contraction of demand and an extension of supply leading to a new market equilibrium at P2Q2
The equilibrium price (P2) is higher and the equilibrium quantity (Q2) is lower than before
The excess demand in the market has been cleared
Real world example: changes to demand that decrease price
Demand for lobsters in Maine, USA has been falling steadily in recent months
This has resulted in a price fall from $12.35 per pound on April 1st to $9.35 per pound on May 1st
Diagram analysis
In recent months, the USA has been experiencing an increasing rate of inflation
Inflation lowers the purchasing power of money in a consumer's pocket and, therefore, effectively reduces their real income
With reduced real income, fewer luxuries are consumed
This led to a decrease in demand for lobsters from D1→D2
At the original market clearing price of P1, a condition of excess supply now exists
The demand for lobsters is less than the supply
In response, suppliers gradually reduce prices
This causes a contraction of supply and an extension of demand, leading to a new market equilibrium at P2Q2
Both the equilibrium price (P2) and the equilibrium quantity (Q2) are lower than before
The excess supply in the market has been cleared
Real world example: changes to supply that decrease price
In order to help meet their climate targets and lower energy costs for households, the EU is providing subsidies for solar panels
Diagram analysis
To help meet its climate change targets and lower household energy bills, the EU has provided a subsidy to solar panel retailers
This causes an increase in supply of S1→S2
At the original market clearing price of P1, a condition of excess supply now exists (surplus)
The supply of solar panels is greater than the demand
In response, sellers in the EU lower prices
This causes an extension of demand and a contraction of supply, leading to a new market equilibrium at P2Q2
The equilibrium price (P2) is lower and the equilibrium quantity (Q2) is higher than before
The excess supply in the market has been cleared
Examiner Tip
MCQ frequently requires you to identify the consequences of dynamic changes in markets, e.g. the new equilibrium point after a change in the market). Memorise the conditions of demand and supply; by doing so, you will save valuable thinking time in the exam.
In structured questions, explaining the steps in the dynamic change is often referred to as analysis and students frequently leave out some steps in the explanation
Here is a systematic process to help build your explanation:
Step 1: From the scenario, identify if the change in condition is on the demand side or supply side
Step2: State which way the demand or supply curve moves and use notation, e.g. S1→S2
Step 3: State the disequilibrium that now exists at the original market price (excess demand or excess supply)
Step 4: State if sellers raise or lower prices to clear the disequilibrium
Step 5: Explain the relevant contraction and extension that occur on the demand and supply curves due to the change in price
Step 6: State the new market equilibrium points e.g. P2Q2
Step 7: Explain the market outcome (is the new price/quantity higher/lower than the original?)
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