Demand and Supply: Curves, Equilibrium and Elasticity

Demand and supply explain how prices are set in a market and why they move. A firm that understands them can see why its sales rise or fall, how a change in its price will affect revenue, and how events such as a poor harvest or a tax change will reach its customers.

This topic covers demand, supply, equilibrium and price elasticity, with the calculations the Institute of Chartered Accountants of Nigeria (ICAN) Business Environment paper expects.

You must be able to draw and read the diagrams, tell a movement along a curve from a shift of the curve, and calculate and interpret elasticity.

Demand

Demand is the quantity of a good that consumers are both willing and able to buy at each price, in a given period. Wanting a car is not demand. Wanting it and having the money to buy it is.

The law of demand says that, other things being equal, a higher price reduces the quantity demanded and a lower price raises it. A demand schedule shows this.

Plotted, these figures give a demand curve that slopes down from left to right.

Why the demand curve slopes down

• Substitution effect. When a good gets dearer, buyers switch to cheaper alternatives.
• Income effect. A lower price leaves buyers with more purchasing power, so they can afford more.
• Diminishing marginal utility. Each extra unit gives less satisfaction than the one before, so buyers will pay less for it.

Conditions of demand: what shifts the curve

The syllabus adds four more conditions. Marketing strategies such as promotion and discounts raise demand. Natural factors such as the season and the weather change what people buy. Availability of credit lets buyers purchase more. A lower cost of borrowing, meaning a lower interest rate, raises demand for goods bought on credit.

Movement along a curve and a shift of the curve

Examiners test this distinction often.

• A change in the good’s own price causes a movement along the demand curve. A fall in price is an expansion of quantity demanded. A rise is a contraction.
• A change in any other factor in the table causes a shift of the whole curve. A shift to the right is an increase in demand. A shift to the left is a decrease.

Types of demand

Exceptions to the law of demand

Normally the demand curve slopes down. An exceptional demand curve slopes up in these cases:

• Giffen goods. Goods whose demand falls when their price falls.
• Goods of ostentation. Luxury goods, such as jewellery, cars and fine fabrics, that are bought as signs of wealth and are in more demand at high prices.
• Fear of a future price rise. When a shortage is expected, buyers may buy more even as prices rise, especially when inflation is worsening.
• Consumer ignorance. Branding and advertising can lead buyers to take a higher price as a sign of quality.

The demand function

The demand function states the quantity demanded as a function of price and the other conditions of demand:

Qx = f (Px, Pr, Y, T, A)

Here Px is the good’s own price, Pr the prices of related goods, Y consumer income, T tastes and A advertising spending. Holding everything but price constant, it reduces to Qx = f(Px).

At ₦1,000: Qd = 140 − 0.02(1,000) = 140 − 20 = 120 bags. At ₦1,500: Qd = 140 − 0.02(1,500) = 140 − 30 = 110 bags. Each ₦100 rise in price cuts quantity demanded by 2 bags.

Individual demand and market demand

Individual demand is what one consumer buys at each price. Market demand is the sum of every consumer’s demand at each price.

Consumer surplus

Consumer surplus is the difference between what consumers are willing to pay for a good and what they actually pay. The demand curve shows what buyers would pay for each unit. Everyone pays the single market price, so buyers who valued the good more than the price gain a surplus.

It is the triangle between the demand curve and the price line, so its area is ½ × base × height, where the base is the quantity bought and the height is the highest price on the curve minus the market price.

For the yam flour demand function, quantity demanded is zero when 140 − 0.02P = 0, which is at P = ₦7,000. At a market price of ₦1,000, 120 bags are bought. Consumer surplus = ½ × 120 × (7,000 − 1,000) = ½ × 120 × 6,000 = ₦360,000.

Supply

Supply is the quantity of a good that producers are willing and able to offer for sale at each price in a given period. The law of supply says that, other things being equal, a higher price raises the quantity supplied. The supply curve slopes up, because a higher price makes production more profitable and covers the higher cost of producing extra units.

Conditions of supply: what shifts the curve

As with demand, a change in the good’s own price moves you along the supply curve (extension or contraction). A change in any other factor shifts the curve (an increase or a decrease in supply).

Types of supply and an exception

• Joint supply. The supply of one product is tied to the supply of another, as with palm oil and palm kernel, or beef and hides.
• Competitive supply. Goods and services that the firm’s resources are best suited to produce, so producing one limits another.
• The backward-bending supply curve of labour. This is the exception to the law of supply. Above a certain wage rate, a worker may choose more leisure and offer fewer hours, so supply of labour falls as the wage rises.

The syllabus also lists the conditions of supply as the good’s own price, prices of other products, cost of inputs, technology, government fiscal policy through taxes and subsidies, weather and natural events, and the number of firms.

Individual supply and market supply

The market supply function that fits these figures is Qs = 10 + 0.08P.

Equilibrium from equations

Put the yam flour demand function, Qd = 140 − 0.02P, against that supply function. Equilibrium is where Qd = Qs.

At ₦1,000, demand is 120 and supply is 90, so there is a shortage of 30. At ₦1,500, demand is 110 and supply is 130, so there is a surplus of 20. Price moves toward ₦1,300.

Producer surplus

Producer surplus is the difference between the price producers receive for a unit and the lowest price they would have accepted for it. It is the triangle between the market price line and the supply curve.

Market equilibrium

The equilibrium price is the price at which the quantity demanded equals the quantity supplied. At that price there is no pressure for change.

• Above the equilibrium price, supply exceeds demand. There is a surplus (excess supply), and sellers cut prices to clear it.
• Below the equilibrium price, demand exceeds supply. There is a shortage (excess demand), and prices rise as buyers compete.

The effects of shifts

Price elasticity of demand

Price elasticity of demand (PED) measures how responsive the quantity demanded is to a change in price.

PED = percentage change in quantity demanded ÷ percentage change in price

Because demand slopes down, PED is negative. Examiners usually ignore the sign and quote the size.

Calculating PED: three examples

The pattern is the rule to remember. When demand is elastic, a price rise cuts revenue, because the fall in quantity outweighs the higher price. When demand is inelastic, a price rise increases revenue. At unit elasticity, revenue is roughly unchanged.

What makes demand more or less elastic

• Availability of substitutes. Many close substitutes make demand elastic.
• Necessity or luxury. Necessities such as salt or electricity are inelastic. Luxuries are elastic.
• Share of income. Items that take a large part of a budget are more elastic.
• Time. Demand becomes more elastic over time, as buyers find alternatives.
• Breadth of definition. Demand for fuel as a whole is less elastic than demand for one brand of petrol.

Other elasticities

Worked example: a poor harvest

1. The flood. It raises the cost of producing rice and cuts the harvest. Supply decreases. The supply curve shifts left.
2. The pay rise. Rice is a normal good, so higher incomes increase demand. The demand curve shifts right.
3. Price. Both shifts push the price up. Less supply and more demand each raise it, so the price rises for certain.
4. Quantity. The two shifts pull in opposite directions. Less supply cuts the quantity. More demand raises it. The final effect depends on which shift is bigger, so say that it is uncertain.
5. Conclusion. Price rises. The change in quantity depends on the relative size of the two shifts.

Notice the structure: identify each event, decide which curve it moves and in which direction, then work out the combined effect on price and quantity separately.

Demand and supply in more detail

Movement or shift: a four-step method

1. Name the market and draw the original demand and supply curves, with the equilibrium.
2. Decide whether the event changes the price of the good itself (a movement along a curve) or one of the conditions (a shift of a curve).
3. Decide which curve shifts and which way: an event that changes buyers’ behaviour shifts demand, and one that changes producers’ costs or numbers shifts supply.
4. Read off the new equilibrium price and quantity, and say whether each rises or falls.

The four combinations

How the market reaches equilibrium

If the price is above equilibrium, sellers want to sell more than buyers want to buy, so there is a surplus. Unsold stock builds up, sellers cut prices, demand rises and supply falls until the surplus is gone. If the price is below equilibrium, buyers want more than sellers offer, so there is a shortage.

Buyers compete and bid the price up, sellers produce more, and demand falls until the shortage ends. The equilibrium is stable because the pressure always pushes toward it.

Elasticity with a worked example

Price elasticity of demand measures how much quantity demanded responds to a price change: PED = % change in quantity demanded ÷ % change in price. The price of rice rises from ₦50,000 to ₦55,000, a rise of 10%. Weekly sales fall from 2,000 to 1,800 bags, a fall of 10%. PED = −10 ÷ 10 = −1, so demand is unit elastic by this simple method. Revenue changes from 50,000 × 2,000 = ₦100 million to 55,000 × 1,800 = ₦99 million, a small fall.

Using the midpoint method, the changes are −10.5% and +9.5%, so PED is about −1.1, slightly elastic, which agrees with the fall in revenue.

Demand is more elastic when there are close substitutes, when the good is a luxury, when it takes a large share of income, and over a longer time. Necessities with no substitutes, such as a basic medicine, have inelastic demand. Income elasticity is positive for normal goods and negative for inferior goods. Cross elasticity is positive for substitutes and negative for complements.

Exam focus: the law of demand, its determinants and the price mechanism

May 2026 (Question 5) and November 2025 (Section A) tested demand. Use this section as an answer plan.

The law of demand

All other things being equal (ceteris paribus), when the price of a good or service rises, the quantity demanded falls, and when the price falls, the quantity demanded rises. Price and quantity demanded move in opposite directions.

Determinants of demand

• Consumer income. Demand for a normal good rises with income. Demand for an inferior good, such as second-hand goods, falls as income rises. Demand for a necessity changes little.
• Prices of related goods. A fall in the price of a substitute reduces demand for the good. A fall in the price of a complement raises it.
• Tastes and preferences. Advertising, fashion and promotions move demand.
• Expectations. If buyers expect a higher future price or higher income, demand today rises.
• Population. A larger or differently structured population changes demand.
• Marketing. Publicity, advertising and sales promotions encourage buying.
• Natural factors. Seasons change demand, for example fans in the dry season and umbrellas in the rainy season.
• Availability of credit. Hire purchase, credit cards and other credit raise demand.
• Cost of borrowing. Lower interest rates encourage people to borrow and buy more.

Movement along a curve and a shift of the curve

A change in the good’s own price causes a movement along the same demand curve. A rise in price is a contraction of demand, and a fall in price is an extension. The curve itself does not move. A change in any other determinant shifts the whole curve. A shift to the right shows more demanded at every price, and a shift to the left shows less.

In the diagram, label the axes price and quantity, draw DD, and show the new curve as D1D1 for an increase or D2D2 for a decrease.

The price mechanism

The price mechanism is the process by which the interaction of supply and demand sets the market price and the quantity of a product that is exchanged. Consumer surplus is the difference between what consumers are willing to pay and the price they actually pay.

Exam focus: determinants of supply and some demand terms

Determinants of supply

• Prices of inputs. Higher input costs reduce supply at every price.
• Technology. Better methods lower cost and raise supply.
• Government fiscal policy. Taxes reduce supply and subsidies raise it.
• Prices of other products (competitive supply). Firms aim to maximise profit, so if the price of another product they could make rises, they may switch to it. For example, a brewery may switch from beer to soft drinks. Such products are made with the same resources.
• Joint supply. Products that are regularly produced together, where one is a by-product of the other. For example, when the price of beef rises and more is supplied, the supply of hides rises too.

A change in the good’s own price moves along the supply curve. A change in any determinant shifts the whole curve.

Demand terms

• Normal goods have demand that rises with income, and substitute goods compete with each other.
• Giffen goods and goods of ostentation are exceptions to the law of demand. Goods of ostentation are seen as symbols of wealth, such as jewellery, cars and fabrics, and luxury items of this kind may be demanded more at high prices than at low ones.
• Fear of a future rise in price. If a shortage is expected, rising expectations of future prices raise demand now, even for necessities whose prices are already rising.
• Consumer ignorance. Through ignorance, consumers may buy more of a good as its price rises, because branding, advertising and other sales promotion can mislead them.

Common mistakes in the exam

• Confusing a movement along a curve with a shift of the curve. Only the good’s own price causes a movement.
• Saying ‘demand falls’ when a price rise has simply reduced the quantity demanded.
• Shifting the wrong curve, for example treating a subsidy to producers as a change in demand.
• Quoting PED as a positive or negative number without saying whether demand is elastic or inelastic.
• Forgetting to calculate percentage changes. PED uses percentages, not raw changes.
• Stating the effect on revenue the wrong way round. Elastic demand and a price rise gives lower revenue.
• Giving a definite answer for quantity when two shifts pull in opposite directions.

Quick revision

• Types of demand: joint, competitive, derived, composite. Exceptions to the law of demand: Giffen goods, ostentation, fear of a price rise, ignorance.
• Demand function Qd = f(P, Pr, Y, T, A). Consumer surplus is ½ × quantity × (highest price − market price). Producer surplus lies between the price and the supply curve.
• Demand needs willingness and ability to pay. The curve slopes down because of the substitution effect, the income effect and diminishing marginal utility.
• Own price causes a movement. Everything else shifts the curve. Learn the conditions of demand and of supply.
• Equilibrium is where quantity demanded equals quantity supplied. A surplus pushes price down. A shortage pushes it up.
• Demand up: price and quantity up. Demand down: both down. Supply up: price down and quantity up. Supply down: price up and quantity down.
• PED = % change in quantity ÷ % change in price. Above 1 is elastic. Below 1 is inelastic.
• Elastic demand: a price rise cuts revenue. Inelastic demand: a price rise raises revenue.
• YED positive is a normal good and negative is inferior. XED positive is substitutes and negative is complements.

Practice questions

These are original questions written in the style of the ICAN exam. Try each one before you open the answer.

Section A style: multiple choice

Section B style: written questions

A further written question

Model answers

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