Demand, supply and price determination

Step 1. Equilibrium. Quantity demanded equals quantity supplied at $2.00, where both are 600. That is the equilibrium price and quantity.

Step 2. At $1.50. 700 are demanded but only 500 supplied, a shortage of 200. Buyers compete for the limited supply, so the price is pushed up towards $2.00.

Step 3. At $2.50. 500 are demanded but 700 supplied, a surplus of 200. Sellers cannot sell all their stock, so they cut the price towards $2.00.

Step 4. What changes along the way. As the price rises from $1.50 to $2.00, quantity demanded contracts from 700 to 600 and quantity supplied extends from 500 to 600. These are movements along the curves, not shifts.

Always say which is larger, demand or supply, and name the result as a shortage or a surplus. Reading the table is one mark; naming and explaining the disequilibrium is the other.

Step 1. Calculate marginal utility as the change in total utility from each extra cup. Cup 1: 20 - 0 = 20. Cup 2: 36 - 20 = 16. Cup 3: 48 - 36 = 12. Cup 4: 56 - 48 = 8. Cup 5: 60 - 56 = 4. Cup 6: 60 - 60 = 0.

Step 2. Describe what happens to marginal utility. Marginal utility falls with every extra cup, from 20 utils to 0. That is diminishing marginal utility.

Step 3. Describe what happens to total utility. Total utility keeps rising while marginal utility is positive, but by smaller amounts each time, and stops rising at the sixth cup, where marginal utility is zero. Total utility is at its maximum where marginal utility is zero.

Step 4. Link this to the demand curve. Because each extra cup adds less satisfaction, the student will only buy more cups if the price falls. That is why the demand curve slopes downward.

C, F, D, E, A, G, B

1. A poor harvest reduces the quantity producers can supply at every price, shifting supply left.
2. At the original price, quantity demanded now exceeds quantity supplied, creating a shortage.
3. Unsatisfied buyers bid against one another, so price rises.
4. The higher price rations the reduced supply, since buyers who value the good least withdraw first, and this is a movement along the demand curve.
5. The higher price simultaneously signals scarcity to producers elsewhere.
6. It also incentivises them, since production is now more profitable, so resources are drawn into the market.
7. A new equilibrium is reached at a higher price and lower quantity, and in the longer run the entry of new supply moderates the price rise.

Notice the chain names all three functions of price as it runs. Weaving the theory through the mechanism, rather than listing it separately, is what earns the analysis marks.

D, G, F, A, B, E, C

1. The price of good X falls, so the budget line pivots outward along the X axis while the intercept on the Y axis is unchanged.
2. The consumer moves to a new tangency on a higher indifference curve, so total consumption of X rises.
3. That total change can be split into two parts.
4. The substitution effect is the change in consumption caused purely by X becoming relatively cheaper than Y, holding real income constant. It is always positive for the good whose price has fallen.
5. The income effect is the change caused by the consumer's real purchasing power having risen, since the same money income now buys more.
6. For a normal good the income effect reinforces the substitution effect, so demand rises unambiguously.
7. For an inferior good the income effect works against the substitution effect, and if it is strong enough to dominate, the good is a Giffen good and the demand curve slopes upward over that range.

Constructing the hypothetical budget line used to isolate the substitution effect is where most candidates lose marks. Draw it parallel to the new budget line and tangential to the original indifference curve.

Define and frame: Define indifference curves and budget lines, and state the consumer optimum condition. Frame usefulness against two tests: does it explain observed behaviour, and does it predict responses to price changes?

Analysis: the strengths: It requires only ordinal preferences, not measurable utility, which is a real advance on marginal utility theory. It derives the demand curve rather than assuming it, and it separates income from substitution effects, which explains inferior and Giffen goods that simple demand analysis cannot.

Analysis: the assumptions: Set out what the model requires: consistent and transitive preferences, full information, and a consumer who optimises. Note that the tangency condition presupposes the consumer can identify the highest attainable curve.

Evaluation: Weigh rather than list. Behavioural evidence shows preferences are unstable and reference-dependent, so the indifference map shifts with framing. Consumers use heuristics rather than optimising. The two-good restriction limits realism. Against that, the model remains a powerful predictive tool at market level even where individual behaviour deviates, since errors may cancel out in aggregate.

Judgement: Reach a conditional conclusion. The model is most useful for explaining directional responses to price changes and for isolating income and substitution effects. It is least useful for predicting individual choices under uncertainty or where framing dominates. State which use you are judging.