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.

Supply and demand diagram with the curves intersecting to set 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 a price set below equilibrium, leaving quantity demanded above quantity supplied
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 a price set above equilibrium, leaving quantity supplied above quantity demanded
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.

Four demand and supply panels showing how a rise or fall in demand or supply moves equilibrium price and quantity
Figure 4: A single set of axes to model the four scenarios below. Practise 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.

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Eight original multiple-choice questions on market equilibrium, excess demand and excess supply, and how shifts in demand and supply change price and quantity.

Practice Questions: 1.2.6 Price Determination

Past paper questions on this topic

Four questions on Price Determination from the Edexcel A-Level papers, 2018–2024, 5 to 25 marks. Each one links straight to the page of the official mark scheme where its answer begins.

Past Paper Questions: 1.2.6 Price Determination