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Price Changes » Causes and Consequences of Price Changes

What you'll learn this session

Study time: 30 minutes

Cambridge spec: 2.5.1, 2.5.2

How a change in demand or a change in supply causes the equilibrium price to change
The four cases: demand rises, demand falls, supply rises, supply falls
The effect of a price change on sales
How to draw and explain the impact of a change in market conditions

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Why do prices change?

Prices move when the equilibrium moves - and that happens when demand or supply shifts

Prices in shops, hotels and markets go up and down all the time. In a market, the price changes when the equilibrium moves. The equilibrium moves when either the demand curve or the supply curve shifts. Remember, a shift is caused by something other than the good's own price. The lessons on shifts of the demand curve and shifts of the supply curve list those causes, so here we focus on what happens next.

Key terms:

Market conditions: the things that affect a market, such as tastes, incomes, costs and the weather. When they change, demand or supply shifts.
Sales: the quantity of a good or service that is actually bought and sold.

The method is always the same: spot the change, decide which curve shifts and which way, then find the new equilibrium.

The four cases

Only four things can happen to a single curve. Learn them as a pattern.

📈 Demand rises

The demand curve shifts right. At the old price there is a shortage, so price rises. The new equilibrium has a higher price and a higher quantity.

📉 Demand falls

The demand curve shifts left. At the old price there is a surplus, so price falls. The new equilibrium has a lower price and a lower quantity.

🏭 Supply rises

The supply curve shifts right. At the old price there is a surplus, so price falls. The new equilibrium has a lower price and a higher quantity.

🌪️ Supply falls

The supply curve shifts left. At the old price there is a shortage, so price rises. The new equilibrium has a higher price and a lower quantity.

Change	Curve that shifts	Equilibrium price	Equilibrium quantity
Demand rises	D to the right	Rises	Rises
Demand falls	D to the left	Falls	Falls
Supply rises	S to the right	Falls	Rises
Supply falls	S to the left	Rises	Falls

Worked example: demand rises

Festival crowds pour in, demand for hotel rooms shifts right, and the equilibrium price and quantity both go up

The town of Kalvora hosts a music festival. Visitors flood in and want hotel rooms. Here is the made-up market for hotel rooms per night.

Price per room ($)	Demand before festival (D)	Demand during festival (D₁)	Supply (S)
60	500	700	100
80	400	600	200
100	300	500	300
120	200	400	400
140	100	300	500

Worked example

Step 1. Before the festival, demand equals supply at $100 and 300 rooms. That is the first equilibrium (P₁, Q₁).

Step 2. The festival raises demand, so use the D₁ column. At $100, demand is 500 and supply is 300. There is a shortage of 200 rooms.

Step 3. Hotels see full rooms and raise prices. Price rises until demand equals supply again, at $120 and 400 rooms. That is the new equilibrium (P₂, Q₂).

Result: price rises from $100 to $120 and sales rise from 300 to 400 rooms.

Drawing it step by step

Put Price on the vertical axis and Quantity on the horizontal axis.
Draw a downward-sloping demand curve (D) and an upward-sloping supply curve (S). Mark the equilibrium P₁ and Q₁.
Draw a second demand curve to the right of the first and label it D₁. Add an arrow to show the shift.
Mark the new equilibrium where D₁ crosses S. Label the new price P₂ and new quantity Q₂.
Check: P₂ is higher than P₁ and Q₂ is bigger than Q₁.

For a fall in demand, draw D₁ to the left. For a change in supply, shift S instead and label it S₁.

Worked example: supply falls

In the country of Merida, a poor harvest destroys part of the coffee crop. This is a made-up market for coffee beans per week.

Price per kg ($)	Demand (D)	Supply before harvest (S)	Supply after harvest (S₁)
4	800	400	200
5	700	500	300
6	600	600	400
7	500	700	500
8	400	800	600

Worked example

Step 1. Before the harvest, the equilibrium is $6 and 600 kg.

Step 2. The poor harvest cuts supply, so use the S₁ column. At $6, demand is 600 and supply is only 400. There is a shortage of 200 kg.

Step 3. Sellers can charge more. Price rises until demand equals supply at $7 and 500 kg.

Result: price rises from $6 to $7 and sales fall from 600 to 500 kg.

The effect on sales

A price change affects the quantity that people buy. A higher price means fewer people are willing and able to buy, so sales tend to fall. A lower price brings more buyers, so sales tend to rise.

Take care here. The price change and the sales change can go the same way or opposite ways, depending on what caused it.

Supply changes: price and sales move in opposite directions. In Merida, price rose and sales fell, a contraction along the demand curve.
Demand changes: price and sales move in the same direction. In Kalvora, price rose and sales rose, because the whole demand curve shifted right.

When both curves shift

Sometimes demand and supply change at the same time. Then you can be sure of one effect but not always both.

Demand rises and supply falls: price rises for certain, but the quantity could go either way.
Demand rises and supply rises: quantity rises for certain, but the price depends on which shift is bigger.

In the exam, say which shift you think is bigger, or say the result is uncertain and explain why.

Common mistakes

Saying "the price change shifts the demand curve". A change in the good's own price causes a movement along the curve. A shift needs another cause.
Moving both curves when only one has a reason to move.
Forgetting to label D₁ or S₁, or to mark the old and new equilibrium.
Mixing up left and right. Rises is right. Falls is left.

Exam-style question

In the island country of Tamora, a popular chef says on television that mango juice is very healthy. In the same month, a pest destroys part of the mango harvest.

(a) Identify which curve shifts because of the chef's comments. [1 mark]

(b) Explain how the chef's comments affect the price of mango juice. [3 marks]

Model answer

(a) The demand curve shifts. (1)

(b) The comments change tastes, so demand rises and the demand curve shifts right (1). At the old price, demand is greater than supply, so there is a shortage (1). Sellers raise the price until demand equals supply again, so the price of mango juice rises (1).

(c) The pest cuts the supply of mangoes, so the supply curve shifts left (1). Supply falling and demand rising both push the price up, so the price rises (1). Demand rising increases sales but supply falling reduces them (1). So the effect on sales is uncertain: sales rise if the shift in demand is bigger, and fall if the shift in supply is bigger (1).

Exam tip

In part (c), the key is that one effect is certain and one is not. State both clearly, and say what the answer depends on.

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