1.2.6 Price Determination

Specification Coverage: Edexcel unit 1.2.6 - Price Determination. Students must learn equilibrium price and quantity, the analysis of excess demand and excess supply, and how shifts in demand or supply curves affect equilibrium.

Market Equilibrium

Market Equilibrium: The point where market demand equals market supply.

Equilibrium Price (Market Clearing Price): The price where there is no excess demand or supply. The market 'clears'.

Equilibrium Quantity: The quantity bought and sold at the equilibrium price.

Standard supply and demand diagram showing intersecting curves at equilibrium price P1 and quantity Q1
Figure 1: Standard supply and demand axes. Intersecting supply (S) and demand (D) curves. The equilibrium point is labelled P on the price axis and Q on the quantity axis.

Disequilibrium

Markets are dynamic (constantly changing). Any change in conditions creates disequilibrium, but competitive market forces push the price back towards equilibrium.

a) Excess Demand (Shortage)

Occurs when: Price is below the equilibrium price (P1).

Result: Quantity Demanded (QD) > Quantity Supplied (QS).

Supply and demand diagram showing price P2 set below equilibrium P1, highlighting the gap between QD and QS as excess demand
Figure 2: Price (P1) set below equilibrium (Pe). At P1, the horizontal gap between the Demand curve (QD) and Supply curve (QS) represents "Excess Demand (Shortage)".

Market Correction: The shortage creates competition among buyers, giving sellers the power to raise prices. As price rises:

  • Extension in QS (movement up supply curve).
  • Contraction in QD (movement up demand curve).

This continues until a new equilibrium is reached.

b) Excess Supply (Surplus)

Occurs when: Price is above the equilibrium price (P1).

Result: Quantity Supplied (QS) > Quantity Demanded (QD).

Supply and demand diagram showing price P3 set above equilibrium P1, highlighting the gap between QS and QD as excess supply
Figure 3: Price (P1) set above equilibrium (Pe). At P1, the horizontal gap between the Supply curve (QS) and Demand curve (QD) represents "Excess Supply (Surplus)".

Market Correction: The surplus means sellers have unsold stock, leading them to lower prices to compete. As price falls:

  • Contraction in QS (movement down supply curve).
  • Extension in QD (movement down demand curve).

This continues until the original equilibrium is restored.

Shifts in Market Equilibrium (Real-World Examples)

Any shift in the demand or supply curve creates a new equilibrium price and quantity.

Diagram template showing initial equilibrium and space to practice shifts for all four scenarios
Figure 4: A single set of axes to model the four scenarios below. Practice drawing the shift, identifying the initial disequilibrium, and showing the new equilibrium P and Q.
Scenario & Cause Curve Shift Effect on Equilibrium Diagram Process
1. Demand Increase
(e.g., product becomes fashionable) 		D curve shifts RIGHT. P ↑, Q ↑ 1. D shifts right.
2. At old P1, excess demand exists.
3. Price rises to new equilibrium P2, Q2.
2. Demand Decrease
(e.g., fall in real incomes for a normal good) 		D curve shifts LEFT. P ↓, Q ↓ 1. D shifts left.
2. At old P1, excess supply exists.
3. Price falls to new equilibrium P2, Q2.
3. Supply Increase
(e.g., a government subsidy or new technology) 		S curve shifts RIGHT. P ↓, Q ↑ 1. S shifts right.
2. At old P1, excess supply exists.
3. Price falls to new equilibrium P2, Q2.
4. Supply Decrease
(e.g., higher raw material costs or a supply shock) 		S curve shifts LEFT. P ↑, Q ↓ 1. S shifts left.
2. At old P1, excess demand exists.
3. Price rises to new equilibrium P2, Q2.

Exam Preparation

  1. Define and identify market equilibrium on a diagram.
  2. Analyse situations of excess demand and excess supply, explaining the market forces that return the market to equilibrium.
  3. Draw clear diagrams to show the impact of changes in demand/supply conditions on equilibrium price and quantity.
  4. Explain the process step-by-step: (1) State which curve shifts and why. (2) Identify the resulting excess demand/supply at the initial price. (3) Explain how price changes to clear the market. (4) State the final effect on P and Q.
  5. Apply this analysis to a wide range of real-world contexts (e.g., weather affecting harvests, new regulations, changes in consumer trends).