What Causes a Shift in the Supply and Demand Curve? FBT ACCA exam

What is a Market?

A market is theoretically referred to as a place where buyers and sellers meet to exchange commodities; it is called trade. For trade to work, a marketplace must have two forces: demand and supply. Demand is the willingness and ability of an individual or group to buy a good or service. On the other hand, supply is when there is the willingness and ability of an individual or group of individuals to sell a good or service.

Before we move to the next section on the supply and demand curve blog, think of enrolling in The Accountant In Business FBT/F1 course to outshine your ACCA career. 

Demand

Demand is indirectly proportional to price, it means the higher the price the lower the quantity demanded, and vice versa.

                 Fig1. Demand Curve of Good X

Fig1. shows a change in the price of good X causes a movement along the demand curve. A rise in prices of good X leads to a fall in Quantity Demand (QD) of good X. And a Fall in prices causes QD to rise. Factors other than price lead to a shift in the demand curve.

Factors Causing Shift in Supply and Demand Curve:

• Substitutes & Complementary Goods:

Substitute goods are those that are the next best alternative good that is there in the market. So the changes in price and quantity of substitute goods affect the demand for each other. For example tea and coffee are substitutes to each other, so a rise in the price of coffee will increase the demand for tea and shift the demand curve for tea upwards. As shown in Fig2, shift from D1 to D2.

Complementary goods are those which are jointly demanded. So any changes in price and quantity of one directly influence the demand for another. For example, tea and milk are complementary goods, if the price of milk rises, the demand for tea will decrease, causing an inwards shift in the demand curve of tea, from D1 to D3.

• Changes in Fashion, Taste and Trends:

One significant reason for shifts in the demand curve is the variations in fashion, trends, and people’s tastes. For example, when wide jeans and cotton pants came into fashion skinny jeans were in the least demand, so the demand curve for skinny jeans shifted downwards causing reduced prices, as illustrated in Fig, the shift from D1 to D3. Similarly, people’s clothing preferences change when there’s a change in weather, jackets and hoodies will not be in demand during summer seasons since there will be a shift in the demand curve for these.

• Changes in Income: 

Demand is vastly influenced by changes in income patterns. If people have higher income levels there will be higher demand for goods and services, the demand curve will move outwards. It’s because people will be able to afford more things and at a higher price range, they won’t have limitations in terms of money. However, if there’s a decline in overall income levels or there’s an inequitable income distribution then the demand curve may shift downwards as people will prefer to buy minimal goods.

                                                              Fig2: Shifts in Demand Curve

Supply: Supply is directly proportional to price, which means the higher the price the higher the quantity supply, and vice versa.

                                                              Fig3: Supply Curve of Good    

Fig. 3 shows a change in the price of good X causes a movement along the supply and demand curve. The rise in prices of good X leads to a rise in supply of good X. And a Fall in prices causes supply to fall. Factors other than price lead to a shift in the supply curve. If you are looking to strengthen your economic & business studies concepts, consider learning under the guidance of Sir Owais Mirchawala.

 Factors Causing Shift in Supply and Demand Curve:

• Size of Industry & Competition:

The size of Industry and the number of competitions is also an important factor that leads to changes in the supply and demand curve. The greater the size of the industry the more outwards the supply curve will shift. It’s because if there are more suppliers in the market, there will higher number of Quantity Supplied, as shown in Fig4, shift from S1 to S2. If suppliers exit the market, the supply decreases, from S1 to S3.

• Technology & Cost of Production:

One of the primary reasons for a shift in the supply and demand curve is variations in technology and cost of production. the cost of production is subject to changes in the price of raw materials and other resources that are directly related for example the supply of cars will be influenced by the price of tyres. Similarly, the rising technological advancements are leading to more efficient ways of increasing supply and reducing the cost of production. This is creating very significant outward shifts in the supply and demand curve, shown in Fig4, from S1 to S2.

• Government Policies (Tax & Subsidy):

Government policies play a very major role in shifting of supply and demand curve. These include the taxation and subsidiary policies that the government introduce to encourage or discourage the supply of certain good and services. For example, cigarettes are usually discouraged by governments and to reduce their supply, they apply heavy taxes on cigarette suppliers. It causes the cigarette supply curve to shift inwards and raise cigarette prices, shown in Fig4, from S1 to S3. Similarly, governments mostly subsidize educational institutions to boost it. This causes the supply and demand curve of education to shift outwards and hence increase its supply, from S1 to S2.

                                                                   Fig4: Shift in Supply Curve

 Market Equilibrium

A point where the Demand curve intersects the supply and demand curve (Quantity Demand= Quantity Supplied) is called Market Equilibrium. This is a point where suppliers and customers both mutually agree on a given price & quantity. The price that is charged at that point is called the Equilibrium Price, and the quantity (Units) demand/or supply is called the Equilibrium Quantity. As shown in Fig, at point ’e’ Demand curve intersects the supply curve, where the price is PKR 60 and the quantity demanded/or supplied is 30 units, this point is Market Equilibrium.

Market Dis-Equilibrium

A situation where market Demand is not equal to market Supply. It occurs when prices are either above or below the equilibrium price, which leads to a conflict between consumer and supplier interests. Hence, the market becomes imbalance, causing either a shortage or surplus in the market:

• Shortage – Demand exceeds Supply
• Surplus – Supply exceeds Demand

Price above equilibrium leads to a surplus in the market, as a supplier is willing to sell, but customers are unable to buy due to high prices. Whereas, a price bellow equilibrium leads to shortages in the market, as the customer is willing to buy, but the supplier is not willing to produce due to lower prices. As shown in Fig, if market prices are set at PKR 80, it will lead to a Surplus in the market, as quantity demanded (QD) is 20 units and quantity supplied (QS) is 40 units, causing a surplus of 20 teams. Similarly, if market prices are set at PKR 40, it will lead to Shortages in the market, as QD is 40 units and QS is 20 units, causing a shortage of 20 teams. To remove the effect of surplus & shortages, Market forces move back prices to PKR 60. Market Dis-equilibrium doesn’t work in the long run because it creates a lot of chaos among suppliers & customers and unstable prices.

                   
                                               Fig5: Market Equilibrium & Dis-Equilibrium

Last Verdicts on Supply and Demand Curve

It can be concluded that all this precisely covers the topic of market forces and market equilibrium. However, there are various other concepts and details in it, several other related topics that cannot be squeezed into one article. Hence, for more knowledge and top-tier resources enroll with us at Mirchawala’s Hub of Accountancy.

This article provides a broad overview of microeconomics. It is intended to introduce key topics to those who have not studied microeconomics, and to offer a revision to those who have done so–ACCA Global