OxfordAQA International AS and A-level Economics: Prices and linked markets (9640)

This guide follows the OxfordAQA International AS and A-level Economics (9640) specification, version 1.2, sections 3.1.2.5 to 3.1.2.7: the determination of market prices, the interrelationship between markets, and how markets and prices allocate resources. Section 3.1 is International AS content, so it also forms part of the International A-level. Every figure below is invented and set in an illustrative country, firm or market. Pair the guide with the revision notes and the practice set. Course pages: the OxfordAQA A-level Economics hub and the checklist. A free diagnostic can show you where to begin. The wider unit is in The Operation of Markets.

What this unit covers

Specification	You must be able to
3.1.2.5	Explain how demand and supply set equilibrium prices; distinguish equilibrium from disequilibrium; explain why excess demand and excess supply change price; analyse causes of changes in price with diagrams; use the significance of different elasticities; explain commodity price fluctuations, including speculation
3.1.2.6	Trace how a change in one market affects related markets (substitutes and complements); use competitive, joint, composite and derived demand, and joint supply
3.1.2.7	Explain the rationing, incentive and signalling functions of prices; show how the price mechanism resolves the basic economic problem; assess its advantages and disadvantages, including extending it into new areas

The demand and supply curves themselves, and the calculation of elasticities, are covered in other units. Here you use them.

Equilibrium and disequilibrium

Equilibrium is the price at which buyers want to buy exactly what sellers want to sell. Nothing pushes the price up or down. Any other price is disequilibrium.

Worked example 1 (Island Y, illustrative). Weekly demand for mangoes is Qd = 480 − 30P and supply is Qs = −60 + 30P, with P in currency units (cu) per kg and Q in tonnes.

Set Qd = Qs: 480 − 30P = −60 + 30P, so 540 = 60P and P = 9 cu. Then Q = 480 − 270 = 210 tonnes. Check with supply: −60 + 270 = 210.

Price	Qd	Qs	Result
6	300	120	Excess demand of 180
9	210	210	Equilibrium
12	120	300	Excess supply of 180

Why price moves. At 12 sellers are left with 180 unsold tonnes. Unsold stock builds up and some fruit rots, so sellers mark prices down to move it. The lower price draws out extra purchases (an extension of demand) while some sellers cut back (a contraction of supply), and the gap narrows. At 6 the reverse happens: buyers cannot all be served, some offer more, and sellers see they can raise price. Price rises, quantity supplied extends and quantity demanded contracts. Always state the direction of both movements along the curves.

In a diagram, price runs up the vertical axis and quantity along the horizontal one. The downward-sloping demand curve meets the upward-sloping supply curve at the equilibrium point. A price above it shows excess supply as the horizontal gap between the curves; a price below it shows excess demand.

Shifts and the size of price changes

A shift of either curve creates a new equilibrium. Name the cause, state which curve moves and in which direction, then take the new price and quantity from where the curves now cross.

Worked example 2 (demand rises). A health campaign adds 60 tonnes of demand at every price: Qd = 540 − 30P. Then 540 − 30P = −60 + 30P, so 600 = 60P and P = 10, Q = 240. Price is up 11.1% and quantity up 14.3%.

Worked example 3 (supply falls). Storm damage removes 90 tonnes of supply at every price: Qs = −150 + 30P. With the original demand, 480 − 30P = −150 + 30P, so 630 = 60P and P = 10.50, Q = 165. Price is up 16.7% and quantity down 21.4%.

Elasticity decides the split between price and quantity. Take the same demand rise but a market where supply responds less: Qs = 120 + 10P. The original equilibrium is still 9 and 210, because 480 − 270 = 120 + 90. After the rise, 540 − 30P = 120 + 10P, so 420 = 40P and P = 10.50, Q = 225.

Supply	New price	Price change	New quantity	Quantity change
Responsive (Qs rises 30 per 1 cu)	10.00	+11.1%	240	+14.3%
Less responsive (Qs rises 10 per 1 cu)	10.50	+16.7%	225	+7.1%

When supply is steeper, producers cannot expand much, so more of the demand rise is absorbed by price. A steeper demand curve works the same way for a supply shift: price moves more and quantity less.

Commodity prices and speculation

Commodity prices swing widely because supply depends on weather and harvests, short-run supply and demand are both unresponsive to price, and so a modest shift needs a large price move to restore equilibrium.

Worked example 4 (Crop K, illustrative). Demand is Qd = 400 − 20P. Supply in a normal harvest is Qs = 100 + 20P.

Harvest	Supply	Price	Quantity	Farmers’ revenue
Normal	100 + 20P	7.5	250	1,875
Poor (supply down 60)	40 + 20P	9.0	220	1,980
Bumper (supply up 60)	160 + 20P	6.0	280	1,680

Prices swing by 20% either way. Farmers’ revenue is higher after the poor harvest and lower after the bumper one, because demand is unresponsive: the price change outweighs the quantity change. That is why producers’ incomes can be unstable even when output is high.

Speculation means buying or selling mainly to gain from an expected change in price. Suppose traders expect Crop K to rise and add 40 units of demand at every price: Qd = 440 − 20P. Then 440 − 20P = 100 + 20P, so P = 8.5, Q = 270. Price has risen 13.3% before any real shortage appeared, and the rise may confirm the traders’ belief and draw in more buyers. This is a self-fulfilling prophecy and it can build a bubble. If the expectation proves wrong, the reverse sell-off brings a sharp fall. Evaluation: speculators can also stabilise prices. Buying when the harvest is good lifts a low price, and selling stocks when it is poor limits the rise. The effect depends on whether traders follow fundamentals or follow each other.

Linked markets

Markets are connected, so a change in one has knock-on effects. Use the correct term.

Term	Meaning	Example direction
Competitive demand	Goods that are substitutes	Price of tea up, demand for coffee up
Joint demand	Goods bought together (complements)	Price of printers down, demand for ink up
Composite demand	One good with several uses	Milk for drinking and for cheese
Derived demand	Demand for an input or product that comes from demand for what it helps to make	Demand for batteries from scooter sales
Joint supply	One process yields two or more goods	Lamb and wool

Chain of reasoning (competitive and joint demand). A poor tea harvest in Country A raises the price of tea. Some tea drinkers move to coffee: coffee’s demand curve moves right and its price rises. Fewer cups of tea mean less milk bought with them, so the demand curve for milk shifts left. Tea pickers are in derived demand, so the lower tea output reduces demand for their labour.

Worked example 5 (composite demand). Milk in Country A is used for drinking, Qd1 = 300 − 20P, and for cheese, Qd2 = 200 − 10P. Total demand is 500 − 30P. Supply is Qs = −100 + 30P, so 600 = 60P, P = 10, Q = 200, split 100 for drinking and 100 for cheese. A cheese boom adds 60 to cheese demand: Qd2 = 260 − 10P. Total demand is 560 − 30P, so 660 = 60P and P = 11, Q = 230. Drinking falls to 300 − 220 = 80 and cheese rises to 260 − 110 = 150. Drinkers lose out because cheese makers bid milk away.

Worked example 6 (derived demand). A firm fits 2 batteries to each scooter. Sales of 40,000 need 80,000 batteries. If scooter sales fall 15% to 34,000, battery demand falls to 68,000, also 15%. A supplier whose only customer is the scooter firm has no other source of demand, so it feels the whole fall.

Worked example 7 (joint supply). A farm region has 50,000 sheep, each giving 3 kg of wool, so wool output is 150 thousand kg. Wool demand is Qd = 300 − 10P (thousand kg, P in cu), so P = 15. Rising demand for lamb pushes the flock up 10% to 55,000, and wool output to 165 thousand kg (55 × 3). Wool is a by-product, so farmers do not raise the flock because of the wool price: supply simply shifts right to 165. The new price is (300 − 165)/10 = 13.50, down 10%. A rise in demand for one joint product lowers the price of the other.

How prices allocate resources

The price mechanism resolves the basic economic problem of what, how and for whom to produce without a central planner, by coordinating the separate decisions of buyers and sellers through price. It has three functions.

• Rationing: when supply is limited, a higher price allocates the good to those willing and able to pay. Example: 120 prints are made and demand is Qd = 300 − 10P. At 12, quantity demanded is 180, an excess of 60. Price rises to 18, where 300 − 180 = 120, and buyers who value a print at less than 18 drop out.
• Incentive: higher prices promise higher profits and so encourage firms to produce more, while workers move to better-paid jobs. Lower prices discourage production.
• Signalling: price changes tell producers and consumers about scarcity and tastes. A rising price for a good signals higher demand or lower supply and directs resources towards it.

What, how and for whom. What: demand for a good rises, its price and profit rise, and firms switch resources into it. How: a tile workshop can use method X (12 workers, 2 machines) or method Y (5 workers, 5 machines). With wages of 40 cu and machines at 120 cu a day, X costs 480 + 240 = 720 and Y costs 200 + 600 = 800, so X is chosen. If wages rise to 60, X costs 960 and Y 900, so firms switch to Y. For whom: goods go to those with the income and willingness to pay.

Advantages. It responds quickly, rewards efficiency, requires no central information gathering and offers consumer choice. Disadvantages. It ignores those without income, may under-provide goods like street lighting, ignores external costs, and can leave inequality and instability.

Assessing “an impersonal method”. For: prices treat every buyer and seller by the same rule, regardless of who they are, so nobody’s favouritism decides. Against: the result still depends on the unequal distribution of income, so those with more money have more votes. Judgement: impersonal does not mean neutral or fair.

Extending markets into new areas. Charging for places on a public clinic’s waiting list, for example, might cut queues and raise funds. But it may be undesirable: access depends on income, and the activity changes. Volunteer helpers paid by the hour may feel their role is now a job and give less. Weigh efficiency gains against equity and the nature of the activity.

Common errors

• Writing “demand increases” for a movement along the curve. A price change causes an extension or contraction.
• Calling any price above equilibrium a “surplus” without saying whose: say excess supply.
• Forgetting that after a shift price and quantity both change, in directions you must state.
• Listing the three functions without applying them to a scenario.
• Treating joint demand and joint supply as the same thing: one is about buying together, the other about producing together.

Official syllabus

OxfordAQA International AS and A-level Economics (9640), specification version 1.2, first teaching September 2020, first AS exams May/June 2021, first A-level exams May/June 2022. Published by OxfordAQA.