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AQA A Level Economics Your notes

3. Price Determination in Competitive Markets

Contents
Demand Curves
Demand Curves: Real World Analysis
Supply Curves
Supply Curves: Real World Analysis
The Determination of Market Equilibrium
Analysing Changes to Market Equilibrium
Price Elasticity of Demand (PED)
Income & Cross Elasticities of Demand
Price Elasticity of Supply (PES)
Interrelationships Between Markets

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Demand Curves
Your notes
An Introduction to Demand
Demand is the amount of a good/service that a consumer is willing and able to purchase at a given
price in a given time period
Effective demand is demand supported by the necessary purchasing power (the ability to pay)
If a consumer is willing to purchase a good, but cannot afford to, it is not effective demand
A demand curve is a graphical representation of the price and quantity demanded (QD) by
consumers
If the data were plotted, it would be an actual curve. Economists, however, use straight lines so as
to make analysis easier
The law of demand states that there is an inverse relationship between price and quantity demanded
(QD), ceteris paribus
When the price rises, the QD falls
When the price falls, the QD rises

Individual and Market Demand

Market demand is the combination of all the individual demand for a good/service
It is calculated by adding up the individual demand at each price level
The Monthly Market Demand for Newspapers in a Small Village

Customer 3 Customer 4 Market Demand

Customer 1 Customer 2

30 15 4 4 53

Individual and market demand can also be represented graphically

Diagram: Market Demand for Children's Swimwear

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Your notes

Boys, girls and total customer demand curves for children's swimwear in July

Diagram analysis
A shop sells both boys and girls swimwear
In July, at a price of $10, the demand for boys swimwear is 500 units and girls is 400 units
At a price of $10, the shops market demand during July is 900 units

Movements Along a Demand Curve

If price is the only factor that changes (ceteris paribus), there will be a change in the quantity
demanded (QD)
This change is shown by a movement along the demand curve

Diagram: Movement Along a Demand Curve

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Your notes

A demand curve shows a contraction in quantity demanded (QD) as prices increase and an extension in
quantity demanded (QD) as prices decrease

Diagram analysis
An increase in price from £10 to £15 leads to a movement up the demand curve from point A to B
Due to the increase in price, the QD has fallen from 10 to 7 units
This movement is called a contraction in QD
A decrease in price from £10 to £5 leads to a movement down the demand curve from point A to point
C
Due to the decrease in price, the QD has increased from 10 to 15 units
This movement is called an extension in QD

The Conditions of Demand

There are numerous factors that will change the demand for a good/service, irrespective of the price
level. Collectively, these factors are called the conditions of demand and include
Changes in real income
Changes in tastes/preferences
Changes in the price of related goods (substitutes and complements)
Changes in the number of consumers

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Future price expectations

Changes to each of the conditions of demand, shift the entire demand curve (as opposed to a
movement along the demand curve) Your notes
Diagram: Shift of the Demand Curve

Changes to any of the conditions of demand shift the entire demand curve left or right, irrespective of
the price level

For example, if a firm increases their Instagram advertising, there will be an increase in demand as
more consumers become aware of the product
This is a shift in demand from D to D1. The price remains unchanged at £7 but the demand has
increased from 15 to 25 units
How Changes to the Conditions of Demand Shift the Entire Demand Curve at Every Price Level

Condition of Explanation Impact Shift Impact Shift

Demand

Changes in real Real Income Income D Income D

income determines how many Increases Increases Decreases Decreas
goods and services Shifts Shifts Le
can be purchased by Right (D→D2)
consumers (D→D1)

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There is a direct
relationship between
income and demand Your notes
for goods/services
Normal goods have a
positive relationship
with income, as income
rises, demand rises,
and vice versa
Inferior goods have an
inverse relationship
with income, as income
rises, demand falls, and
vice versa

Changes in If goods/services Good D Good D

taste/preferences become more becomes Increases becomes Decreas
desirable, then more Shifts less Shifts Le
demand for them preferable Right preferable (D→D2)
increases (D→D1)
There is a direct
relationship between
changes in
taste/preferences and
demand
Advertising or
branding can change
tastes/preferences

Changes in the Changes in the price of Price of D for Price of D for

prices of substitute goods will Good A Good B Good A Good B
substitute goods influence the demand Increases Increases Decreases Decreas
for a product/service Shifts Shifts Le
(Related goods) Right (D→D2)
There is a direct (D→D1)
relationship between
the price of good A
and demand for good
B
E.g. The price of a Sony
60" TV (good A)

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increases so the
demand for LG 60" TV
(good B) increases Your notes
Changes in the Changes in the price of Price of D for Price of D for
prices of complementary goods Good A Good B Good A Good B
complementary will influence the Increases Decreases Decreases Increase
goods demand for a Shifts Left Shifts
product/service (D→D2) Right
(Related goods) (D→D1)
There is an inverse
relationship between
the price of good A
and demand for good
B
For example, the price
of printer ink (good A)
increases so the
demand for ink printers
(good B) decreases

Changes in the If the population size Population D Population D

number of of a country changes Increases Increases Decreases Decreas
consumers over time, then the Shifts Shifts Le
demand for Right (D→D2)
goods/services will (D→D1)
also change
There is a direct
relationship between
the changes in
population size and
demand
Demand will also
change if there is a
change to the age
distribution in a
country, as different
ages demand different
goods and services,
e.g an ageing
population will buy
more hearing aids

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Future price If consumers expects Expectations D Expectations D

expectations the price of a price will rise Increases price will fall Decreas
Your notes
good/service to Shifts Shifts Le
increase in the future, Right (D→D2)
they will purchase it (D→D1)
now, and demand will
increase
If consumers expects
the price of a
good/service to
decrease in the future,
they will wait to
purchase it later, and
demand will decrease

Examiner Tips and Tricks

The difference between a movement along the demand curve and a shift in demand is essential to
understand. You will be repeatedly examined on this, and it is important that you use the correct
language to show that you understand the difference between a change in quantity demanded and
a change in demand.
When price changes (ceteris paribus), there is a movement along the demand curve resulting in a
change to quantity demanded. When a condition of demand changes, there is a shift of the entire
demand curve resulting in a change to demand.

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Demand Curves: Real World Analysis

Your notes
Real-World Example One: A Decrease in Demand
During the COVID-19 pandemic, the demand for restaurant dining fell sharply due to changes in various
conditions of demand
Reduced disposable income as unemployment increased
Changing preferences for safer dining options
Government restrictions on indoor dining

Diagram: Decrease in Demand for Restaurant Dining

Changes in these conditions of demand all shifted the entire demand curve left

(This image is placeholder - image under construction)

Diagram analysis
During to the pandemic, there was a downturn in the economy, causing unemployment levels to rise
As a result, there was a reduction in the real income of consumers
Restaurant dining is considered a normal good, demand falls when consumer incomes fall
The demand curve shifts to left from D → D1 as fewer consumers opt to eat out

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The price level remains the same (P1), demand falls from Q1 → Q2
Real-World Example Two: An Increase in Demand Your notes
In 2023, global demand for Taylor Swift concerts surged as a result of her music becoming more
popular
This is considered to be a change in tastes and preferences

Diagram: Increase in Demand for Concert Tickets

Changes in the popularity of her concerts shifted the entire demand curve right, irrespective of the
price level

(This image is a placeholder - image under construction)

Diagram analysis
Positive reviews of Swift's concert and the popularity of her songs, along with changes in consumer
tastes and preferences, have caused an increase in demand for concert tickets at each price level
The demand curve shifts right D → D1 as more consumers buy concert tickets and the quantity
demanded rises Q1 → Q2

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Supply Curves
Your notes
An Introduction to Supply
Supply is the amount of a good/service that a producer is willing and able to supply at a given price
in a given time period
A supply curve is a graphical representation of the price and quantity supplied by producers
If the data were plotted, it would be an actual curve. Economists, however, use straight lines so as
to make analysis easier
The supply curve is sloping upward as there is a positive relationship between the price and quantity
supplied (QS)
Rational profit maximising producers would want to supply more as prices increase in order to
maximise their profits
The law of supply states that there is a positive (direct) relationship between quantity supplied and
price, ceteris paribus
When the price rises, the QS rises
When the price falls, the QS falls

Individual and Market Supply

Market supply is the combination of all the individual supply for a good/service
It is calculated by adding up the individual supply at each price level
The Monthly Market Supply of Bread from 4 Bakeries in a Small town

Bakery 3 Bakery 4 Market Supply

Bakery 1 Bakery 2

600 180 320 1400 loaves

300

Diagram: Individual & Market Supply Curves

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Your notes

Market supply for smart phones in December is predominantly a combination of iPhone and Samsung
supply

Diagram analysis
In New York City, the market supply for smart phones in December is predominantly a combination of
iPhone and Samsung supply
At a price of $1000, the supply of iPhones is 300 units and the supply of Samsung phones is 320 units
At a price of $1,000, the market supply of smart phones in New York City during December is 620 units

Movements Along a Supply Curve

If price is the only factor that changes (ceteris paribus), there will be a change in the quantity supplied
(QS)
This change is shown by a movement along the supply curve

Diagram: Movement Along a Supply Curve

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Your notes

There is an extension in quantity supplied (QS) as prices increase and a contraction in quantity supplied
(QS) as prices decrease

Diagram analysis
An increase in price from £7 to £9 leads to a movement up the supply curve from point A to B
Due to the increase in price, the quantity supplied has increased from 10 to 14 units
This movement is called an extension in QS
A decrease in price from £7 to £4 leads to a movement down the supply curve from point A to C
Due to the decrease in price, the quantity supplied has decreased from 10 to 7 units
This movement is called a contraction in QS

The Conditions of Supply

There are several factors that will change the supply of a good/service, irrespective of the price level.
Collectively, these factors are called the conditions of supply and include:
Changes to the costs of production
Changes to indirect taxes and subsidies
Changes to technology
Changes to the number of firms
Weather events

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Future price expectations

Goods in joint and competitive supply Your notes
Changes to any of the conditions of supply shift the entire supply curve (as opposed to a movement
along the supply curve)
Diagram: Shift of the Supply Curve

A graph that shows how changes to any of the conditions of supply shift the entire supply curve left or
right, irrespective of the price level

E.g. If a firm's cost of production increases due to the increase in price of a key resource, then there will
be a decrease in supply as the firm can now only afford to produce fewer products
This is a shift in supply from S to S1. The price remains unchanged at £7 but the supply has
decreased from 10 to 2 units
An Explanation of how each of the Conditions of Supply Shifts the Entire Supply
Curve at Every Price Level

Condition of Explanation Factor Shift Factor Shift

Supply

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Changes to COP S COP S

If the price of raw Your notes
costs of Increases decreases, Decreases increases,
production materials or other shifting left shifting
(COP) costs of production (S→S1) right
change, firms (S→S2)
respond by changing
supply

Indirect taxes Taxes S Taxes S

Any changes to Increase decreases, Decrease increases,
indirect taxes shifting left shifting
change the costs of (S→S1) right
production for a firm (S→S2)
and impact supply

Subsidies Subsidy S Subsidy S

Changes to producer Increases increases, Decreases decreases,
subsidies directly shifting shifting left
impact the costs of right (S→S1)
production for the (S→S2)
firm

New Technology S Technology S

technology New technology Increases increases, Decreases decreases,
increases shifting shifting left
productivity and right (S→S1))
lowers production (S→S2)
costs
Ageing technology
can have the
opposite effect

Change in the No. of Firms S No. of Firms S

number of The entry and exit of Increases increases, Decreases decreases,
firms in the firms into the market shifting shifting left
industry have a direct impact right (S→S1)
on the supply (S→S2)

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E.g. If ten new firms

start selling building
materials in Hanoi, the Your notes
supply of building
material will increase

Weather Drought S Good S

events Droughts or flooding decreases, Weather increases,
can cause a supply shifting left shifting
shock in agricultural (S→S1) right
markets (S→S2)
A drought will cause
supply to decrease.
Unexpectedly good
growing conditions
can cause supply to
increase

Future price If firms expects the Expectations S Increases Expectations S

expectations price of a price will rise Shifts Right price will fall Decreases
good/service to (S→S2) Shifts Left
increase in the future, (S→S1)
they will start
supplying more
If firms expects the
price of a
good/service to
decrease in the
future, they will start
supplying less

Goods in joint When there is an Supply of S good A Supply of the S good B

supply increase of supply of one good Increases other good Increases
one good in joint rises rises Shifts Right
supply (e.g. beef), Shifts Right (S→S2)
possibly due to (S→S2)
higher prices, there
will be an increase in
supply of the other
good too (e.g.
leather)

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Goods in Farmers can produce Supply of S good A Supply of the S

competitive many goods which one good Increases other good Decreases
Your notes
supply are competitive in rises falls Shifts Left
supply Shifts Right (S→S1)
(S→S2)
E.g. A farmer can
grow wheat or
potatoes. When they
increase the supply of
potatoes, the supply
of wheat decreases

Examiner Tips and Tricks

Several of the conditions of supply change the costs of production. However, be sure to explain
each condition as its own point before linking it to the cost of production, e.g. a change in indirect
taxation.
A common error by students is to explain that a subsidy (for example, a £3,000 subsidy for each
electric vehicle produced) shifts the demand curve for electric vehicles to the right. This is incorrect.
The subsidy will shift the supply curve to the right. Then due to the lower price, there will be a
movement along the demand curve (extension of quantity demanded) to create a new market
equilibrium.

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Supply Curves: Real World Analysis

Your notes
Real-World Example One: A Decrease in Supply
In 2023, the supply of UK-grown tomatoes declined as a consequence of rising energy costs
Energy prices increased due to supply chain issues, causing the cost of operating greenhouses to
rise

Diagram: Supply of UK Tomatoes

A fall in supply of tomatoes shifts supply curve to the left

Diagram analysis
An increase in the costs of production from imported energy results in a shift left of the entire supply
curve from S1 → S2
The price remains the same at P1
The quantity supplied falls from Q1 → Q2

Real-World Example Two: An Increase in Supply

Advances in technology have led to an increase in the supply of lettuce

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Greater mechanisation and innovations in genetically modified food increase productivity and
output
Diagram: Supply of Food Your notes

A rise in the supply of lettuce the shifts supply curve to the right

Diagram analysis
Improvements in farming technology cause a shift to the right of the entire supply curve from S1 → S2
Price remains the same at P1
The quantity supplied rises from Q1 to Q2

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The Determination of Market Equilibrium

Your notes
Price Determination in Markets
In a market system, prices for goods/services are determined by the interaction of demand and
supply
A market is any place that brings buyers and sellers together
Markets can be physical (e.g. McDonald's) or virtual (e.g. eBay)
Buyers and sellers meet to trade at an agreed-upon price
Buyers agree the price by purchasing the good/service
If they do not agree on the price, then they do not purchase the good/service and are exercising
their consumer sovereignty
Based on this interaction with buyers, sellers will gradually adjust their prices until there is an
equilibrium price and quantity that works for both parties
At the equilibrium price, sellers will be satisfied with the rate/quantity of sales
At the equilibrium price, buyers are satisfied with the utility that the product provides

Market Equilibrium
Equilibrium occurs in a market when demand = supply
At this point, the price is called the equilibrium or market-clearing price
This is the price at which sellers are clearing (selling) their stock at an acceptable rate

Diagram: Market Equilibrium

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Your notes

Equilibrium is at PQ. The market clearing price of P & quantity at Q

Diagram analysis
Any price above or below P creates disequilibrium in this market
Disequilibrium occurs whenever there is excess demand or excess supply in a market

Market Disequilibrium
Disequilibrium occurs when demand is not equal to supply
If demand > supply, the market is facing excess demand
If demand < supply, the market is facing excess supply

Disequilibrium: excess demand

Excess demand occurs when the demand is greater than the supply
It can occur when prices are too low or when demand is so high that supply cannot keep up with it

Diagram: Excess Demand for Electric Scooters

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Your notes

The quantity demanded is greater than quantity supplied

Diagram analysis
At a price of P1, the quantity demanded of electric scooters (Qd) is greater than the quantity supplied
(Qs)
There is a shortage (excess demand) in the market equivalent to QsQd

Market response
This market is in disequilibrium
Sellers are frustrated that products are selling so quickly at a price that is obviously too low
Some buyers are frustrated as they will not be able to purchase the product
Sellers realise they can increase prices and generate more revenue and profits
Sellers gradually raise prices
This causes a contraction in QD as some buyers no longer desire the good/service at a higher
price
This causes an extension in QS as other sellers are more incentivised to supply at higher prices
In time, the market will have cleared the excess demand and arrive at a position of equilibrium, PeQe

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Different markets take different lengths of time to resolve disequilibrium

E.g. Retail clothing can do so in a few days. Whereas the housing market may take several months Your notes
or even years
Disequilibrium: excess supply
Excess supply occurs when the supply is greater than the demand
It can occur when prices are too high or when demand falls unexpectedly
During the later stages of the pandemic, the market for face masks was in disequilibrium

Diagram: Excess Supply Covid-19 Face Masks

The quantity supplied is greater than quantity demanded for Covid-19 face masks during the later
stages of the pandemic

Diagram analysis
At a price of P1, the quantity supplied of face masks (Qs) is greater than the quantity demanded (Qd)
There is a surplus in the market (excess supply) equivalent to QdQs

Market response
This market is in disequilibrium
Sellers are frustrated that the masks are not selling and that the price is obviously too high

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Some buyers are frustrated as they want to purchase the masks but are not willing to pay the high
price
Sellers will gradually lower prices in order to generate more revenue Your notes
This causes a contraction in QS as some sellers no longer desire to supply masks
This causes an extension in QD as buyers are more willing to purchase masks at lower prices
In time, the market will have cleared the excess supply and arrive at a position of equilibrium, PeQe

Examiner Tips and Tricks

Memorise the rule that shortages arise when the price is below equilibrium whereas surpluses arise
when the price is above the equilibrium.

Equilibrium in Demand & Supply Schedules

A demand and supply schedule shows the quantity demanded and the quantity supplied of a product
at different price levels
Demand and supply schedules can be used to identify equilibrium and disequilibrium

Demand and Supply Schedule Per Week For YEEZY Boost 700 Wave Runner Trainers

Price ($) Quantity Demanded (QD) Quantity Supplied (QS) Excess Demand/Supply

300 1200 500 Excess demand = 700

400 1000 650 Excess demand = 350

500 800 800 Equilibrium

600 600 950 Excess supply = 350

700 400 1100 Excess supply = 700

At a price of $500, the market is in equilibrium

The QD = QS (800 units)
At a price of $300 & $400, there is excess demand as the product is more affordable for consumers

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Producers supply less at lower prices as they make less profit per unit
Producers are incentivised to supply more when prices are higher Your notes
At a price of $600 & $700, there is excess supply as the high price has eliminated some buyers from
the market
Producers would love to sell at this high price but in order to clear their stock, they have to lower
the price & move towards equilibrium

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Analysing Changes to Market Equilibrium

Your notes
Causes & 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 One: 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: Increase in Demand

Demand increases for desks due to a temporary change in tastes/fashions

Diagram analysis

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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
Your notes
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 expansion 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 Tips and Tricks

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 expansion of supply
(not a shift of supply)

Real World Example Two: 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: Decrease in Supply

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Your notes

The supply of plantains in Puerto Rico falls due to a supply shock caused by Hurricane Fiona

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 raised prices
This causes a contraction of demand and an expansion 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 Three: 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 the 1st April to $9.35 per pound on the 1st May

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Diagram: Decrease in Demand

Your notes

Demand for lobsters falls due to a decrease in real income

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 so 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 expansion 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

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Real World Example Four: Changes to Supply that

Decrease Price Your notes
In order to help meet their climate targets and to lower energy costs for households, the EU is
providing subsidies for solar panels

Diagram: Increase in Supply

The supply of solar panels increases in the EU due to a per unit subsidy

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 expansion 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

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The excess supply in the market has been cleared

Your notes

Examiner Tips and Tricks

MCQ may require 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 essay 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 expansion 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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Price Elasticity of Demand (PED)

Your notes
The Definition & Calculation of PED
The law of demand states that when there is an increase in price, there will be a fall in the quantity
demanded
Economists are interested by how much the quantity demanded will fall
Price elasticity of demand reveals how responsive the change in quantity demanded is to a change in
price
The responsiveness is different for different types of products

Calculation of PED
PED can be calculated using the following formula

% change in quantity demanded % △ in QD

PED = =
% change in price % △in P

To calculate a % change, use the following formula

new value − old value

% Change = × 100
old value

Worked Example
A firm raises the price of its products from $10 to $15. Its sales fall from 100 to 40 units per day.
Calculate the PED of its products
Step 1: Calculate the % change in QD

40 − 100
% △QD = × 100
100

% △QD = − 60 %

Step 2: Calculate the % change in P

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15 − 10
%△P = x 100
10
Your notes
% △ P = 50 %

Step 3: Insert the above values in the PED formula

% △ in QD
PED =
% △in P

− 60
PED =
50

PED = − 1. 2

Step 4: Final answer = 1.2

The PED value will always be negative so economists ignore the sign and present the answer as 1.2

Examiner Tips and Tricks

In Paper 3 you are occasionally given the PED value and the %Δ in Price - you are then asked to find
the %Δ in Qd. Follow the standard math procedure as follows:
1. Substitute the values provided into the equation
2. Substitute X for %Δ in Qd
3. Solve for X

Worked Example
The price elasticity of demand for smart phones is -2. It can be concluded that a 10% reduction in
their price would be a percentage change in demand of:
A. -7.4%
B. -20.0%

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C. +7.4%
D. +20.0% Your notes
Step 1: Substitute the values provided into the equation

% ∆in QD
PED =
% ∆ in P
Step 2: Substitute X for %Δ in Qd

X
+2 =
−10 %
Step 3. Solve for X

X = 20 %
Quantity demanded increases by 20%

Interpreting PED Values

PED Classifications

Value Name and Diagram Explanation

0
Perfectly Inelastic The QD is completely unresponsive to
a change in P (very theoretical value
e.g. heart transplant is extremely
inelastic but possibly not perfectly)

0 →1 Relatively Inelastic

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The %∆ in QD is less than proportional

to the %∆ in P (e.g. addictive products)
Your notes

1 Unitary Elasticity
The % ∆ in QD is exactly equal to the
%∆ in P

1→∞ Relatively Elastic

The %∆ in QD is more than proportional
to the %∆ in P (e.g. luxury products)

∞ Perfectly Elastic
The %∆ in QD will fall to zero with any
%∆ in P (highly theoretical elasticity)

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Your notes

PED & Total Revenue

Knowledge of PED is important to firms seeking to maximise their revenue
Sales revenue will be maximised
If their product is price inelastic in demand, they should raise their prices
If their product is price elastic in demand, then they should lower their prices
This rule is used when firms choose to use [popover id="F_vUGukEe4aWRck1" label="price
discrimination"] to maximise their revenue
They lower their prices for elastic sections of their market e.g. off peak train travel
They increase prices for inelastic sections of their market e.g. peak hour train trave
The benefits of this rule can be illustrated using a demand curve
A shallow curve represents a price-elastic product
A steep curve represents a price inelastic product

Diagram: Elastic Demand Curve

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Your notes

A small decrease in price from P1 → P2 causes a large increase in quantity demanded from Q1 → Q2

Diagram analysis
When a good/service is price elastic in demand, there is a greater than proportional increase in the
quantity demanded to a decrease in price
A small decrease in price leads to a larger increase in QD
TR is higher once the price has been decreased

(P 2 ×Q 2 ) > (P 1 ×Q 1 )

Diagram: Inelastic Demand Curve

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Your notes

A large increase in price from P1 → P2 causes a small decrease in quantity demanded from Q1 → Q2

Diagram analysis
When a good/service is price inelastic in demand, there is a smaller than proportional decrease in the
quantity demanded to an increase in price
A large increase in price leads to a smaller decrease in QD
TR is higher once the price has been increased

(P 2 ×Q 2 ) > (P 1 ×Q 1 )

The Factors that Influence PED

Some products are more responsive to changes in prices than other products
The factors that determine the responsiveness are called the determinants of PED and include:
Availability of substitutes: good availability of substitutes results in a higher value of PED
(relatively elastic)
Addictiveness of the product: addictiveness turns products into necessities, resulting in a low
value of PED (relatively inelastic)
Price of product as a proportion of income: the lower the proportion of income the price
represents, the lower the PED value will be. Consumers are less responsive to price changes on

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cheap products (relatively inelastic)

Time period: In the short term, consumers are less responsive to price increases, resulting in a low
value of PED (relatively inelastic). Over a longer period of time, consumers may feel the price Your notes
increase more and will then look for substitutes, resulting in a higher value of PED (relatively elastic)

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Income & Cross Elasticities of Demand

Your notes
Defining & Calculating Income Elasticity of Demand
(YED)
Changes in income result in changes to the demand for goods/services
Economists are interested in how much the quantity demanded will change for different
products
Income elasticity of demand (YED) reveals how responsive the change in quantity demanded is to a
change in income
YED can be calculated using the following formula

% change in quantity demanded % △ in QD

YED = =
% change in income % △in Y

Worked Example
A consumer's income rises from £100 to £125 a week. They originally consumed 12 bagels at the
local bakery, but this increased to 15 bagels a week.
Calculate the YED of the bagels
Step 1: Calculate the % change in QD

15− 12
% △ QD = × 100
12

% △ QD = 25 %

Step 2: Calculate the % change in Y

125 − 100
% △Y = x 100
100

% △Y = 25 %

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Step 3: Insert the above values in the YED formula

Your notes
% △ in QD
PED =
% △in Y

25
Y ED =
25

Y ED = 1

Interpreting YED Values

The YED value can be positive or negative and the value is important in determining the type of good
A good with a positive YED value is considered to be a normal good
Normal goods can be classified as necessities or luxuries
A good with a negative YED value is considered to be an label goes here

The Value Of YED Determines the Type of Good & Response to Changes in Income

Value Type of Good Explanation

0→1 Normal Demand increases when income increases

necessity
Income inelastic, which means that it is relatively unresponsive to a
change in income

YED > 1 Normal luxury Demand increases when income increases

Income elastic, which means that it is relatively responsive to a change
in income

YED < Inferior Good Demand decreases when income increases

0

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Defining & Calculating Cross Elasticity of Demand

(XED) Your notes
Changes in the prices of complementary goods and substitutes affect the demand for related
products
Cross price elasticity of demand (XED) reveals how responsive the change in quantity demanded for
good A is to a change in price of good B
The responsiveness is different for different types of products
XED can be calculated using the following formula:

% change in quantity demanded of good A % △ in QDA

XED = =
% change in price of good B % △in P B

Worked Example
Leading into the release of FIFA 22 Ultimate, EA Sports discounted the price of FIFA 21 from £90 to
£60. A game store in Winchester saw an increase in sales of their PlayStation 5 consoles. Prior to the
discount, they were selling 50 units a week, and after the discount this increased to 80 units.
Calculate the XED and explain the relationship between the two products
Step 1: Calculate the % change in QDA

80− 50
% △ QDA = × 100
50

% △ QD A = 60 %

Step 2: Calculate the % change in PB

60 − 90
%△P B = x 100
90

% △ P B = − 33.3 %

Step 3: Insert the above values in the XED formula

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% △ in QDA
X ED =
% △in P B Your notes

60 %
X ED =
−33.3 %

X ED = −1.8

Step 4: Explain the relationship between the two products

The negative sign indicates that these two products are complements and the high value suggests
they are strong complements

Worked Example
The price of good Y, a substitute for X, rises from £50 to £60. As a result, the quantity demanded of
good X rises from 2 units to 4 units per month.
What is the value of the cross elasticity of demand for good X with respect to Y?
A: +0.4
B: -0.4
C: +2.5
D:-2.5
Step 1: Calculate % change in QDA using formula

4−2
% △ QDA = × 100
2

% △ QDA = 50 %

Step 2: Calculate % change in PB using formula

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60 − 50
%△PB = x 100
50
Your notes
% △ P B = 20 %

Step 3: Insert the above values in the XED formula

% △ in QDA
XED =
% △in P B

+50 %
XED =
+20 %

XED = +2.5

The positive sign indicates that these two products are substitutes and the high value suggests they
are strong substitutes

Interpreting XED Values

The XED value can be negative or positive, and the value is important in determining the type of good.
The size of the number determines how closely related goods are
A good with a negative XED value is considered to be a complementary good
A good with a positive XED value is considered to be a substitute good
Using XED Values to Identify if Goods are Complements, Substitutes, or Unrelated

Value Name Explanation

XED < Complementary The negative value indicates the two goods are complements
0 goods
The higher the value the stronger the relationship

XED > Substitutes The positive value indicates the two goods are substitutes
0
The higher the value, the stronger the relationship

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XED = Unrelated goods A value of zero indicates that there is no relationship between the
0 two goods.
Your notes
The closer to zero, the weaker the relationship is

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Price Elasticity of Supply (PES)

Your notes
The Definition & Calculation of PES
The law of supply states that when there is an increase in price (ceteris paribus), producers will
increase the quantity supplied and vice versa
Economists are interested by how much the quantity supplied will increase
Price elasticity of supply (PES) reveals how responsive the change in quantity supplied is to a change
in price
The responsiveness is different for different types of products
PES can be calculated using the following formula"

% change in quantity supplied % △ in QS

PES = =
% change in price % △in P
To calculate a % change, use the following formula:

new value − old value

% Change = × 100
old value

Worked Example
In recent months, the price of avocados has increased from AU$ 0.90 to AU$ 1.45. Bewdley Farm
Shop in Margaret River has sought to maximise their profits by increasing the quantity supplied to
the market. They have been able to increase sales from 110 units a week to 120 units a week.
Calculate the PES of avocados and explain one reason for the value
Step 1: Calculate the % change in QS

120 − 110
% △ QS = × 100
110

% △ QS = 9. 1 %

Step 2: Calculate the % change in P

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1. 45 − 0. 90
%△P = x 100
0. 90
Your notes
% △ P = 61 %

Step 3: Insert the above values in the PES formula

% △ in QS
PE S =
% △in P

9. 1 %
PE S =
61 %

PE S = 0. 15

Step 4: Explain one reason for the value

The PES value of 0.15 indicates that avocados are very price inelastic in supply. Even with a
significant increase in price, suppliers are unable to supply more due to the time it takes to grow
additional avocados

Worked Example
The diagram below shows two market demand curves (D1 and D2) and the market supply curve (S) for
Good X

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(This image is a placeholder - new image in production)

The price elasticity of supply of Good X when the demand curve shifts from D1 to D2 is: Your notes
A +0.25
B +2.0
C +4.0
D +7.5
Step 1: Calculate the % change in QS

180 − 100
% △ QS = × 100
100

% △ QS = 80 %
Step 2: Calculate the % change in P

240 − 200
%△P = x 100
200

% △ P = 20 %
Step 3: Insert the above values into the PES formula

% △ in QS
PES =
% △in P

80 %
PES =
20 %

PES = 4

The PES value of 4 indicates Good X is elastic in supply. Suppliers are very responsive to a change in
price, they are able to increase output easily

Examiner Tips and Tricks

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When doing elasticity calculations, make sure that your final answer for PES is not expressed as a
percentage. This is a common error and loses marks.
Your notes
In Paper 3 multiple choice questions, you are occasionally given the PES value and the %Δ in QD. You
have to find %Δ in price. Follow the standard math procedure as follows:
1. Substitute the values provided into the equation
2. Substitute X for %Δ in price
3. Solve for X

Interpreting PES Values

The Values of PES vary from 0 to Infinity (∞) & they are Classified as Follows

Value Name Explanation

0 Perfectly The QS is completely unresponsive to a

Inelastic change in P (e.g. fixed number of seats in a theatre)

0→1 Relatively The %∆ in QS is less than proportional

Inelastic to the %∆ in P (e.g agricultural products)

1→ ∞ Relatively The %∆ in QS is more than proportional

Elastic to the %∆ in P (e.g t-shirts)

∞ Perfectly The %∆ in QS will fall to zero with any %∆ in P. However, supply is unlimited at a
Elastic particular price. This is a very theoretical scenario

The Factors that Influence Price Elasticity of Supply

Some products are more responsive to changes in prices than other products
The factors that determine the responsiveness of PES include:
1. Mobility of the factors of production
If producers can quickly switch their resources between products, then the PES will be more elastic.
E.g. If prices of hiking boots increase and shoe manufacturers can switch resources from producing
trainers to boots, then boots will be price elastic in supply
2. The rate at which costs of production increase
It costs more to produce each additional unit of output (marginal cost). If the rate of the marginal cost

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increase is low, the quantity supplied will be more elastic. However, if marginal costs rise quickly, then
the quantity supplied will be more inelastic
3. Ability to store goods Your notes
If products can be easily stored then PES will be higher (elastic) as producers can quickly increase
supply (e.g. tinned food products). An inability to store products results in lower PES (inelastic)
4. Spare capacity
if prices increase for a product and there is a capacity to produce more in the factories that make
those products, then supply will be elastic. If there is no spare capacity to increase production, then
supply will be inelastic
5. Time period
In the short run, producers may find it harder to respond to an increase in prices as it takes time to
produce the product (e.g. avocados). However, in the long run they can change any of their factors of
production so as to produce more

Examiner Tips and Tricks

Many students confuse PES with PED and inadvertently answer questions using knowledge from
PED. When faced with PES questions, tell yourself to think like a producer (not a consumer!) and it
will help you to stay focused on providing the correct answer.

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Interrelationships Between Markets

Your notes
Different Types of Interrelationships Between Markets
Markets do not operate in isolation. Interrelationships can exist between markets in several ways
The Interrelationships Between Markets

Relationship Explanation Example

Joint demand When consumers use two products together, Coffee and sugar
also known as complementary goods
Cereal and milk
The change in price of one good impacts the
demand for the other good Smart phones and mobile
apps

Competitive Two goods are used for the same purpose, also Cinema tickets and online
demand known as substitute goods streaming services
The change in price of one good impacts the Tea and coffee
demand for the other good
E-books and printed
books

Composite Two or more goods require the same input to Cheese and yogurt
demand make them require the same input
(milk)
An increase in production of one good could
lead to a decrease in supply of another good, as Growing crops or raising
less of the input is available livestock requires the
same input (land)

Derived Demand for a good or service arises from the Aluminium and cars
demand demand for another good or service
Labour and goods &
The demand for inputs is derived from the services
demand for the final product

Joint supply The supply of two different goods stems from Beef and cow leather
the same source
Poultry meat and feathers
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The increase in production of one good will Honey and beeswax

increase the production of another good.
Your notes
The second good may be a by-product of
the first good

Analysing Interrelated Markets

1. Analysing markets in joint demand
Changes to the price of one good shift the entire demand curve of a complementary good

Diagram: Markets for Mobiles & Mobile Apps

Increases in price of mobile phones, shift the entire demand curve of mobile apps to the left
Diagram analysis
Market for mobiles
An increase in price for mobiles from P1→P2 leads to a movement up the demand curve
Due to the increase in price, there is a contraction in QD from Q1→Q2
Market for mobile apps
As a result of price increase for mobile phones, there will be an decrease in demand for mobile apps
(the complementary good) as more consumers become buy less
This causes a shift in demand from D1 to D2. The price remains unchanged at P1 but the demand has
decreased from Q1→Q2
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2. Analysing markets in joint supply

As the production of beef increases, the supply of leather will increase (as it is a by-product of beef) Your notes

Diagram: Market for Beef & Leather

An increase in demand for beef increases the the supply of leather

Diagram analysis
Market for beef
If the real income of individuals of a country increase, there may be an increase in demand for beef
(considered a normal good)
This causes a shift in demand from D1 → D2. The price has increased from P1 → P2 and the quantity
has increased from Q1 → Q2
Market for leather
When there is an increase of quantity of beef, there will be an increase in the supply of leather
This is a shift in supply from S1 to S2. The price increased from P1 → P2 and the supply has
decreased from Q1 → Q2

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