Demand, Supply and Market Equilibrium: Practice Questions

These are original questions written for Marlbridge, for revision and practice on this content. They are not reproduced past-paper questions, and they do not replicate the exam’s exact structure, question count or mark tariffs — the IB holds copyright in its own papers. Use these alongside the official past papers available through your school or the IB store.

Related: Demand, Supply and Market Equilibrium revision notes

IB Economics papers are not divided into lettered sections. Paper 1 offers a choice of one question from three, each split into part (a) (10 marks) and part (b) (15 marks). Paper 2 offers a choice of one question from two, split into parts running from (a) to (g) and totalling 40 marks: (a) 4 marks in two sub-parts of 2, (b) 5 marks in two sub-parts, then (c) to (f) at 4 marks each and (g) at 15. The question below is modelled on that outline, (a) to (g) for 40 marks; it has no data text of its own, so it is practice for the part pattern, not a replica of a live Paper 2 question.

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Question 1

(a) (i) Define “ceteris paribus”. [2]

(a) (ii) Explain why it matters when stating the law of demand as a relationship between price and quantity demanded. [2]

(b) Using a fully labelled demand and supply diagram, explain what happens to the equilibrium price and quantity of umbrellas if a period of unusually heavy rainfall increases consumer demand for umbrellas, with supply unchanged. [5]

(c) Explain the three functions performed by the price mechanism in a competitive market. [4]

(d) In the market for a good, both demand and supply increase simultaneously. Explain why the effect on equilibrium quantity is more certain than the effect on equilibrium price. [4]

(e) For the market for coffee, state whether each of the following causes a movement along, or a shift of, the demand or supply curve: (i) the price of coffee rises (ii) a new study links coffee to health benefits, increasing consumer preference for it (iii) the price of tea (a substitute) falls (iv) the cost of fertiliser used by coffee growers rises [4]

(f) Using a demand and supply diagram, show consumer surplus and producer surplus at the market equilibrium for umbrellas, and explain why total (social) surplus is maximised at this equilibrium. [4]

(g) Evaluate the extent to which the price mechanism, operating through free markets, achieves a more efficient allocation of resources than a centrally planned economy. [15]

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Answers

(a) (i) “Ceteris paribus” means “all other things being equal” or “holding all other factors constant” [1] [1].

(a) (ii) It matters because the law of demand isolates the relationship between price and quantity demanded specifically [1] — without holding other determinants (income, tastes, related prices) constant, a change in quantity demanded could not be attributed to price alone, since several things would be changing at once [1].

(b) Increased demand for umbrellas shifts the demand curve rightward [1]. With supply unchanged, the new intersection of demand and supply occurs at a higher equilibrium price and higher equilibrium quantity [2]. A correctly labelled diagram should show the original equilibrium (Pe, Qe), the demand curve shifted right (D to D1), and the new equilibrium (Pe1, Qe1) at a higher price and quantity than before [2].

(c) Signalling — price changes tell producers and consumers that something in the market has changed, for example a price rise signalling rising demand or falling supply [1]. Incentive — a higher price incentivises producers to supply more and consumers to demand less, and vice versa for a lower price [2]. Rationing — price rations a scarce good to those most willing and able to pay for it, without any central authority allocating output directly [1].

(d) A rightward shift of demand, with supply unchanged, raises equilibrium price and quantity; a rightward shift of supply, with demand unchanged, lowers equilibrium price but raises equilibrium quantity [1]. When both shift right together, both effects on quantity point the same way (upward), so equilibrium quantity definitely rises [2]; but the two curves’ effects on price work in opposite directions, so the overall direction of the price change is ambiguous without more specific information about the relative size of each shift [1].

(e) (i) Movement along the demand curve [1]. (ii) Shift of the demand curve (rightward, an increase in demand) [1]. (iii) Shift of the demand curve (leftward, a decrease in demand, since tea and coffee are substitutes) [1]. (iv) Shift of the supply curve (leftward, a decrease in supply, since production costs have risen) [1].

(f) Consumer surplus is the area below the demand curve and above the equilibrium price, representing the extra value consumers receive beyond what they paid [1]. Producer surplus is the area above the supply curve and below the equilibrium price, representing revenue producers receive beyond the minimum they would have accepted [1]. Total surplus is maximised at the competitive equilibrium because that is where marginal benefit equals marginal cost — at any other quantity, a unit is produced whose cost to society exceeds its benefit, or a unit of benefit to society goes unproduced, so total surplus is lower [2].

(g) For the price mechanism / free markets (7 marks): the price mechanism performs the signalling, incentive and rationing functions automatically, with no single participant needing to plan them [1] [1] [1]; this decentralised coordination avoids the need for a planner to gather and process the vast amount of information the price mechanism aggregates automatically through millions of individual decisions [1] [1]; competitive markets also give producers a continuous incentive to innovate and cut costs to survive, which a planned system, lacking a profit motive, does not automatically replicate [1]; and consumers in a market system can signal changing preferences immediately through their spending, whereas a planner must estimate demand in advance and can misjudge it badly [1]. Against / limits (5 marks): free markets can misallocate resources where market failure occurs, for example under-providing public goods or over-producing goods with negative externalities, which a planner could in principle correct directly [1] [1]; markets can also produce a highly unequal distribution of income, since resources go to those with purchasing power rather than greatest need [1] [1]; and markets can be unstable, with prices and output fluctuating through the business cycle in ways a planner might aim to smooth [1]. Judgement (3 marks): the free market is generally more efficient at allocating resources where information is dispersed and preferences change quickly, since no planner can process that information as fast as decentralised prices do [1]; but a pure free market performs poorly wherever market failure is significant, which is why most real economies are mixed economies combining market allocation with government intervention to correct its specific failures [1]; the comparison is therefore best framed as a question of degree and of correcting specific failures, not an all-or-nothing choice between the two systems [1].

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Where marks are usually lost

• Confusing a movement along a curve (caused by a change in the good’s own price) with a shift of the curve (caused by a change in any other determinant).
• Diagrams without correctly labelled axes, curves and equilibrium points.
• Explaining price changes in words only, when the question specifically asks for diagram-based analysis.
• Naming only one or two of the price mechanism’s three functions (signalling, incentive, rationing) when a question asks for all of them.
• Claiming a definite direction for both price and quantity when demand and supply shift simultaneously — only one of the two is certain unless the relative size of each shift is also given.
• Answering the extended part (g) at only an “explain” level, without a final judgement that directly compares the two systems.

For condensed recall notes on this topic, see the Demand, Supply and Market Equilibrium revision notes.