In this video, we walk through 5 BAR practice questions teaching about the effect of supply, demand, and elasticity on a product. These questions are from BAR content area 1 on the AICPA CPA exam blueprints: Business Analysis
The best way to use this video is to pause each time we get to a new question in the video, and then make your own attempt at the question before watching us go through it.
Also be sure to watch one of our free webinars on the 6 “key ingredients” to an extremely effective & efficient CPA study process here…
The Effect of Supply, Demand, and Elasticity on a Product
To succeed on the BAR CPA Exam, you’ll need to demonstrate a clear understanding of how supply and demand forces interact in the market—and how elasticity helps quantify consumer and producer behavior. In this post, we’ll walk through the most important concepts you need to know, using real-world examples and explanations derived from targeted practice questions.
What It Means When the Demand Curve Shifts
The demand curve illustrates the relationship between a product’s price and the quantity that consumers are willing and able to buy. Typically downward sloping, the curve shows that as price decreases, demand increases—and vice versa.
But what happens when the entire demand curve shifts?
- A shift to the right means demand has increased at all price levels.
- A shift to the left means demand has decreased at all price levels.
This shift doesn’t occur due to a change in the product’s own price, but rather due to outside factors such as:
- Changes in consumer income
- Changes in tastes or preferences
- The price of related goods (substitutes or complements)
- Consumer expectations
- Changes in population or demographics
Example: If streaming services like Netflix become more popular and affordable, demand for movie theater tickets may decrease, shifting the demand curve for tickets to the left.
What It Means When the Supply Curve Shifts
The supply curve shows how much of a product producers are willing to offer for sale at various prices. It typically slopes upward—higher prices incentivize producers to supply more.
A shift in the supply curve reflects a change in the conditions of production:
- A shift to the right means an increase in supply.
- A shift to the left means a decrease in supply.
Common causes of a leftward supply shift include:
- Higher input costs (labor, materials)
- New regulations or taxes
- Expectations of higher future prices (producers hold back)
- Natural disasters or disruptions to production
Example: If the cost of fertilizer and labor rises sharply, strawberry farmers may reduce production. This leads to a leftward shift in the supply curve for strawberries.
Measuring Elasticity of Demand
Price elasticity of demand tells us how sensitive consumers are to changes in price. It is calculated using this formula:
Percentage Change in Quantity Demanded = Elasticity × Percentage Change in Price
A few key takeaways:
- If elasticity > 1, demand is elastic (sensitive to price changes).
- If elasticity < 1, demand is inelastic (not very sensitive).
- If elasticity = 1, demand is unit elastic.
CPA exam questions often require you to calculate the expected percentage change in demand based on a known elasticity and a percentage change in price.
Example: If a product has an elasticity of 2.5 and the price increases by 4%, you multiply:
2.5 × 4% = 10%
This means quantity demanded would drop by 10% (direction is implied).
Price Ceilings, Freezes, and Their Market Impact
A price ceiling is a government-imposed limit on how high a price can go. When a ceiling is set below the equilibrium price, it creates a shortage—because quantity demanded exceeds quantity supplied at the capped price.
Price freezes are a form of strict price ceiling. They lock prices in place, even during periods of high demand or rising costs.
Example: During a heatwave, the government caps the price of bottled water at $1, even though market conditions would normally push it to $2. As a result, more people want water, but suppliers may limit shipments—leading to a shortage.
Rent control is another classic example. A city may cap rent at $800 even if the market rate is $1,200. This often leads to long waitlists and deterioration in housing supply, as landlords withdraw from the market.
Complementary and Substitute Goods: How They Affect Demand
The demand for a product can change based on the price of related goods:
- Complementary goods are used together (e.g., cameras and memory cards, or coffee and creamer). When the price of one falls, demand for the other increases.
- Substitute goods are used in place of each other (e.g., beef and chicken, or coffee and tea). When the price of one rises, demand for the other increases.
Understanding this helps you analyze how one market affects another.
Example: If the price of digital cameras drops due to new tech, more people will buy cameras—and also buy memory cards, a complement. This increases demand for memory cards.
Example: If the price of ground beef rises, people may switch to chicken. This increases demand for chicken, a substitute.
Summary of Key Facts
Here are five must-know concepts to remember:
- A leftward shift in the demand curve means less is demanded at all prices, often due to falling income, weaker preferences, or cheaper alternatives.
- A leftward shift in the supply curve means producers supply less at every price, often due to rising input costs or supply constraints.
- Price elasticity of demand measures how much demand changes when price changes—calculated by multiplying elasticity by the percent price change. - A price ceiling or freeze below the market price causes a shortage because demand rises while supply falls or remains limited.
- Complementary goods move together; substitutes move in opposite directions. A price change in one affects the demand for the other.
By mastering these core ideas and knowing how to apply them in different scenarios, you’ll be well-prepared for questions on supply, demand, and elasticity on the BAR section of the CPA Exam.
