MICROECONOMICS – DEMAND AND SUPPLY ANALYSIS CHAINS

These are the CORE chains of A Level Economics Paper 4.

Almost every essay eventually comes back to:

• demand

• supply

• elasticity

• costs

• incentives

• welfare

• market adjustment

If these chains become automatic, Paper 4 becomes MUCH easier.

DEMAND INCREASE CHAIN

• Consumer income rises

• Purchasing power increases

• Demand increases

• Demand curve shifts right

• Equilibrium price rises

• Equilibrium quantity rises

• Firm revenue rises

• Firms may expand production

• Derived demand for labour rises

• Employment rises

• National output may increase

Evaluation additions:

• depends on PED

• depends on spare capacity

• may mainly cause inflation if supply is inelastic

• short-run and long-run effects may differ

DEMAND DECREASE CHAIN

• Consumer confidence falls

• Households reduce spending

• Demand decreases

• Demand curve shifts left

• Price falls

• Quantity falls

• Firm revenue falls

• Output contracts

• Firms reduce employment

• Economic growth slows

Evaluation:

• depends on severity of recession

• necessities may be less affected

• government intervention may offset fall

Written and Compiled By Sir Hunain Zia (AYLOTI), World Record Holder With 154 Total A Grades, 11 World Records and 7 Distinctions, Educate A Change.

MOVEMENT ALONG DEMAND CURVE – PRICE RISE

• Price rises

• Quantity demanded contracts

• Consumers buy fewer units

• Consumers may switch to substitutes

• Firm sales fall

• Revenue may fall if PED is elastic

Evaluation:

• necessities often have inelastic demand

• addiction reduces responsiveness

• brand loyalty may weaken effect

MOVEMENT ALONG DEMAND CURVE – PRICE FALL

• Price falls

• Quantity demanded expands

• Consumers buy more units

• Sales volume rises

• Revenue may rise if PED > 1

• Market share may increase

Evaluation:

• depends on income levels

• demand may remain weak during recession

• substitutes affect responsiveness

SUPPLY INCREASE CHAIN

• Costs of production fall

• Firms become more profitable

• Firms increase supply

• Supply curve shifts right

• Equilibrium quantity rises

• Equilibrium price falls

• Consumer welfare improves

• Consumer surplus rises

• Inflationary pressure falls

Evaluation:

• depends on strength of demand

• profits may still fall if prices fall sharply

• long-run impact may differ

SUPPLY DECREASE CHAIN

• Production costs rise

• Profit margins shrink

• Firms reduce supply

• Supply curve shifts left

• Prices rise

• Quantity falls

• Inflationary pressure increases

• Consumers lose welfare

Evaluation:

• depends on elasticity

• firms may absorb costs temporarily

• subsidies may offset impact

INDIRECT TAX CHAIN

• Government imposes indirect tax

• Production costs increase

• Supply decreases

• Supply curve shifts left

• Market price rises

• Quantity sold falls

• Consumer spending power falls

• Government tax revenue rises

Evaluation:

• depends on PED and PES

• consumers bear more burden if demand inelastic

• may create black markets

• may worsen inequality

SUBSIDY CHAIN

• Government gives subsidy

• Production costs fall

• Firms increase supply

• Prices fall

• Quantity rises

• Consumers access cheaper products

• Consumption increases

• Welfare may improve

Evaluation:

• opportunity cost exists

• may increase government debt

• effectiveness depends on elasticity

• firms may keep some subsidy as profit

Written and Compiled By Sir Hunain Zia (AYLOTI), World Record Holder With 154 Total A Grades, 11 World Records and 7 Distinctions, Educate A Change.

PRICE CEILING CHAIN

• Government sets maximum price below equilibrium

• Excess demand created

• Quantity demanded exceeds quantity supplied

• Shortages develop

• Queues emerge

• Black markets may appear

• Product quality may fall

Evaluation:

• improves affordability short-run

• may help low-income households

• long-run shortages may worsen

• effectiveness depends on enforcement

PRICE FLOOR CHAIN

• Government sets minimum price above equilibrium

• Excess supply created

• Surplus develops

• Producers gain higher incomes

• Consumers pay higher prices

• Government may purchase surplus

Evaluation:

• costly for government

• consumer welfare falls

• inefficiency may increase

• depends on PED/PES

RENT CONTROL CHAIN

• Rent ceiling introduced

• Rent prices fall

• Housing demand rises

• Supply of rental housing falls

• Housing shortages develop

• Landlords reduce maintenance

• Black markets possible

Evaluation:

• improves affordability temporarily

• may discourage new housing investment

• depends on population growth

• government housing programs may help

MINIMUM WAGE CHAIN

• Government raises minimum wage

• Labour costs rise

• Firms may reduce labour demand

• Unemployment may rise

• Worker incomes increase

• Consumption may increase

• Poverty may reduce

Evaluation:

• depends on elasticity of labour demand

• monopsony markets may avoid unemployment rise

• productivity may improve

• automation may accelerate

Written and Compiled By Sir Hunain Zia (AYLOTI), World Record Holder With 154 Total A Grades, 11 World Records and 7 Distinctions, Educate A Change.

ELASTICITY ANALYSIS CHAINS

PED ELASTIC DEMAND CHAIN

• Price falls

• Quantity demanded rises proportionately more

• Total revenue rises

• Firm profits may increase

• Market share expands

Evaluation:

• luxury goods usually elastic

• many substitutes increase elasticity

• advertising may reduce elasticity

PED INELASTIC DEMAND CHAIN

• Price rises

• Quantity demanded changes slightly

• Consumer expenditure rises

• Firm revenue increases

Evaluation:

• necessities usually inelastic

• addiction increases inelasticity

• long-run elasticity often greater

YED POSITIVE CHAIN

• Consumer incomes rise

• Demand for normal goods rises

• Output expands

• Employment rises

• Economic growth may increase

Evaluation:

• luxury goods have high YED

• recession sharply affects luxury demand

YED NEGATIVE CHAIN

• Consumer incomes rise

• Demand for inferior goods falls

• Revenue decreases

• Firms may reduce output

Evaluation:

• consumer habits matter

• some inferior goods remain stable

XED SUBSTITUTE GOODS CHAIN

• Price of coffee rises

• Demand for tea rises

• Tea firms gain revenue

• Production expands

• Employment may rise

Evaluation:

• depends on closeness of substitute

• brand loyalty weakens relationship

XED COMPLEMENTARY GOODS CHAIN

• Car demand falls

• Petrol demand falls

• Petrol stations lose revenue

• Employment may fall in industry

Evaluation:

• strength of complementarity matters

• technological changes weaken links

PES ELASTIC SUPPLY CHAIN

• Price rises

• Firms respond quickly

• Output expands significantly

• Shortages reduced

Evaluation:

• spare capacity important

• manufacturing usually more elastic long-run

PES INELASTIC SUPPLY CHAIN

• Price rises

• Supply changes little

• Prices rise sharply

• Inflationary pressure worsens

Evaluation:

• agriculture often inelastic short-run

• time period extremely important

Written and Compiled By Sir Hunain Zia (AYLOTI), World Record Holder With 154 Total A Grades, 11 World Records and 7 Distinctions, Educate A Change.

CONSUMER SURPLUS CHAIN

• Market price falls below willingness to pay

• Consumers gain additional satisfaction

• Consumer surplus rises

• Welfare improves

Evaluation:

• difficult to measure accurately

• subjective valuations differ

PRODUCER SURPLUS CHAIN

• Producers receive higher prices

• Revenue exceeds minimum acceptable price

• Producer surplus rises

• Profitability improves

• Investment may increase

Evaluation:

• may reduce consumer welfare

• depends on market structure

PERFECT PAPER 4 ANALYSIS FORMULA

Memorise this:

CHANGE
→ DIRECT EFFECT
→ MARKET EFFECT
→ BUSINESS EFFECT
→ CONSUMER EFFECT
→ MACRO EFFECT
→ EVALUATION

EXAMPLE

Oil prices rise
→ transport costs rise
→ supply decreases
→ prices rise
→ inflation increases
→ real incomes fall
→ consumption falls
→ economic growth slows

Evaluation:

• depends on oil dependency

• subsidies may reduce effect

• short-run and long-run impact differ

ULTRA-IMPORTANT QUICK CHAINS

Inflation Chain

Costs rise
→ SRAS falls
→ price level rises
→ inflation increases
→ purchasing power falls

Unemployment Chain

AD falls
→ output falls
→ firms reduce labour demand
→ unemployment rises
→ incomes fall

Economic Growth Chain

Investment rises
→ AD rises
→ output rises
→ employment rises
→ incomes rise
→ living standards improve

Trade Deficit Chain

Imports exceed exports
→ net exports negative
→ AD falls
→ output falls
→ unemployment may rise

Currency Depreciation Chain

Currency value falls
→ exports become cheaper
→ export demand rises
→ AD rises
→ output rises
→ inflation may rise

Written and Compiled By Sir Hunain Zia (AYLOTI), World Record Holder With 154 Total A Grades, 11 World Records and 7 Distinctions, Educate A Change.

MOST IMPORTANT PAPER 4 RULE

Never stop at ONE effect.

Weak student:
“tax increases price”

Strong Paper 4 student:
“tax increases production costs, supply falls, prices rise, real incomes fall, demand contracts and economic growth may slow depending on PED and government policy.”

That development is where A grades live.

Written and Compiled By Sir Hunain Zia (AYLOTI), World Record Holder With 154 Total A Grades, 11 World Records and 7 Distinctions, Educate A Change.