Edexcel IAL Economics: Price determination, surplus, the price mechanism, indirect taxes and subsidies (YEC11) – Revision Notes

These revision notes condense section 1.3.4 Price determination, items 1 to 4, of the Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics specification (YEC11), Issue 2, June 2018. It is Unit 1 content. For full explanations and first worked examples, read the study guide. Then try the practice questions, the Edexcel Economics hub, the printable checklist and the free diagnostics. All figures are invented.

Key definitions

Term	Meaning
Equilibrium	Quantity demanded equals quantity supplied, so the price has no tendency to change (1a)
Excess demand	Quantity demanded is greater than quantity supplied at the price, which is below equilibrium (1c)
Excess supply	Quantity supplied is greater than quantity demanded, which is above equilibrium (1c)
Consumer surplus	Willingness to pay minus price paid: area under demand, above price (2a)
Producer surplus	Price received minus the minimum supply price: area above supply, below price (2a)
Price mechanism	Price adjustments that allocate scarce resources through rationing, incentive and signalling (3a)
Indirect tax	A tax on spending, paid to government by sellers, either specific (per unit) or ad valorem (percentage) (4a)
Incidence	How the burden of a tax, or the gain from a subsidy, is shared between consumers and producers (4b, 4d)
Subsidy	A payment by government to producers, usually per unit, which lowers their costs (4c)

One market for the whole page

Market R is an invented weekly market, with price P in currency units (cu).

Demand: Qd = 476 - 8P       Supply: Qs = 12P - 24
Equilibrium: 476 - 8P = 12P - 24  ->  500 = 20P  ->  P = 25 cu, Q = 276

The price-axis intercept of demand is 476 / 8 = 59.5 cu. The lowest supply price is 24 / 12 = 2 cu.

Method in steps: equilibrium

1. Set Qd equal to Qs.
2. Collect the P terms on one side and solve for P.
3. Substitute P into both equations. If the two quantities differ, you have made an arithmetic slip.
4. State units and say what the numbers mean.

Excess demand and supply

Price	Qd	Qs	Result
30 cu	236	336	excess supply of 100
25 cu	276	276	equilibrium
20 cu	316	216	excess demand of 100

Chain for excess supply: stock builds up, sellers cut price, quantity demanded extends, quantity supplied contracts, the gap shrinks to zero. Reverse it for excess demand. Always name the movement along each curve.

Shifts of demand and supply (1b)

Shift	Price	Quantity
Demand rises	up	up
Demand falls	down	down
Supply rises	down	up
Supply falls	up	down

Worked reminder: demand falls by 40 at every price, so Qd = 436 - 8P. Then 436 - 8P = 12P - 24 gives 460 = 20P, so P = 23 cu and Q = 12 x 23 - 24 = 252. The price falls by 2 cu, and quantity falls by 24.

Remember the causes for each curve. Demand shifts come from income, tastes, prices of related goods, population and expectations. Supply shifts come from costs, technology, taxes and subsidies, and number of firms. A change in price itself is never a shift.

Surplus (2a, 2b)

Method for a linear market: surplus = 1/2 x base (quantity) x height (price gap).

Consumer surplus = 1/2 x (59.5 - 25) x 276 = 4,761 cu
Producer surplus = 1/2 x (25 - 2)    x 276 = 3,174 cu
Total surplus = 7,935 cu

Event	Consumer surplus	Producer surplus
Demand rises	up	up
Demand falls	down	down
Supply rises	up	depends on how elastic demand is
Supply falls	down	depends on the quantity lost against the price gained

For a supply increase, check the numbers before you claim producers gain: they sell more units but at a lower price. Consumer surplus rises when price falls and quantity rises.

Must-know distinction: producer surplus is not profit. It is measured against marginal cost, so fixed costs are not subtracted.

Price mechanism (3a, 3b)

Function	One-line explanation	Example chain
Rationing	Scarce goods go to those willing and able to pay	Price rises, marginal buyers drop out
Incentive	Prices and profits reward a change in behaviour	Higher price makes extra output profitable
Signalling	Price changes carry information	A rising price tells firms that demand exceeds supply

Local: quick, personal, small scale. National: adjusts through wages, rents and prices, often slowed by time lags. Global: transmits shocks across borders quickly, but responses take time, and poorer buyers may be rationed out.

Evaluation points for the price mechanism:

• It handles huge numbers of decisions without central planning.
• It rations by ability to pay, not by need.
• Information may be poor and responses slow.
• Prices may leave out wider costs and benefits.

Indirect taxes (4a, 4b)

A specific tax shifts supply vertically upward by the tax amount. For a tax of 5 cu on Market R, Qs becomes 12(P - 5) - 24 = 12P - 84.

476 - 8P = 12P - 84  ->  560 = 20P  ->  P = 28 cu, Q = 252
Consumer burden: (28 - 25) x 252 = 756 cu  (3 of the 5 cu per unit, 60%)
Producer burden: (25 - (28 - 5)) x 252 = 504 cu  (2 of the 5 cu, 40%)
Government revenue: 5 x 252 = 1,260 cu
Consumer surplus 3,969 cu; producer surplus 2,646 cu
Welfare loss: 1/2 x 5 x (276 - 252) = 60 cu

Check: 3,969 + 2,646 + 1,260 = 7,875, and 7,935 - 7,875 = 60.

Incidence rule: the less elastic side bears more. Here demand slope is 8 and supply slope is 12 in Q against P, so demand is the less price-responsive side and consumers carry 12 / 20 = 60%. At equilibrium, price elasticity of demand is -8 x 25 / 276 = -0.72 and price elasticity of supply is 12 x 25 / 276 = 1.09.

For a tax, the shift in supply is the tax. The price paid by consumers rises by less than the tax unless demand is perfectly inelastic or supply perfectly elastic. Method for incidence: consumer burden per unit = new price minus old price, and producer burden per unit = tax minus consumer burden. Multiply each by the new quantity.

Impact summary:

Group	Effect
Consumers	Higher price, lower quantity, lower consumer surplus
Producers	Lower net price, lower quantity, lower producer surplus
Government	Tax revenue, equal to tax per unit x new quantity

Ad valorem taxes: the supply curve pivots, so the vertical gap widens as price rises.

Subsidies (4c, 4d)

A subsidy shifts supply vertically downward by its value. For 5 cu on Market R, Qs becomes 12(P + 5) - 24 = 12P + 36.

476 - 8P = 12P + 36  ->  440 = 20P  ->  P = 22 cu, Q = 300
Consumers pay 22 cu: down 3 cu.  Producers receive 27 cu: up 2 cu.
Cost to government: 5 x 300 = 1,500 cu

Gains split 3 : 2 in favour of consumers, matching the tax. Evaluation: the subsidy raises output and may help a good with wider benefits, but it costs the government, has an opportunity cost, and may lead to dependence. The less price-responsive the demand, the more of the gain goes to consumers; the less price-responsive the supply, the more goes to producers.

Quick self-test

Use Market R above unless a question says otherwise.

1. State the equilibrium price and quantity.
2. What is the excess at a price of 30 cu?
3. What is the excess at a price of 20 cu?
4. Demand falls by 40 at every price. Give the new equilibrium.
5. Calculate consumer surplus at the original equilibrium.
6. Calculate producer surplus at the original equilibrium.
7. A 5 cu per unit specific tax is imposed. Give the new price paid by consumers, quantity and tax revenue.
8. What percentage of the 5 cu tax is paid by consumers?
9. A 5 cu per unit subsidy replaces the tax. Give the new price, quantity and government cost.
10. A world price rises after a harvest failure and farmers elsewhere plant more. Which function of the price mechanism is that?
11. True or false: the more elastic side of the market bears more of an indirect tax.
12. True or false: producer surplus is another name for profit.

Answers

1. P = 25 cu, Q = 276.
2. Excess supply of 100 (Qd 236, Qs 336).
3. Excess demand of 100 (Qd 316, Qs 216).
4. P = 23 cu, Q = 252.
5. 1/2 x 34.5 x 276 = 4,761 cu.
6. 1/2 x 23 x 276 = 3,174 cu.
7. 28 cu, 252 units, 1,260 cu.
8. 3 / 5 = 60%.
9. 22 cu, 300 units, 1,500 cu.
10. Incentive (the price acts as a signal and the higher return is the incentive).
11. False. The less elastic side bears more.
12. False. It is measured against marginal cost and excludes fixed costs.

Must-know distinctions

• Movement along a curve (price change) versus shift of a curve (non-price factor).
• Excess supply (price too high) versus excess demand (price too low).
• Consumer surplus (area under demand, above price) versus producer surplus (area above supply, below price).
• Legal liability for a tax (sellers) versus economic incidence (shared by elasticity).
• Tax shifts supply up and subsidy shifts it down by the same type of vertical distance.
• Impact (what happens to price, quantity, revenue) versus incidence (who bears the burden).

Where marks are usually lost

• Writing “demand increases” when only price has changed.
• Leaving out units, or giving a surplus without halving the triangle.
• Using the price paid by consumers as the producers’ price after a tax.
• Taking tax revenue as tax x old quantity.
• Using 50:50 incidence without checking elasticity.
• Describing the three functions without applying them to the given market.
• Stating that a subsidy is good or bad without comparing cost with benefit.
• Describing a diagram without naming axes, curves and the new equilibrium.

Official syllabus

Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics (YEC11), Specification, Issue 2, June 2018, section 1.3.4 Price determination. Published by Pearson Education Limited.