When a component supplier loses orders after customers adopt a competing technology, the auditor connects the development to demand, inventory recoverability, and financial reporting assumptions.
Demand describes quantities buyers are willing and able to purchase at different prices, with other conditions held constant. A buyer ordinarily purchases fewer units at a higher price and more units at a lower price.
Supply describes quantities sellers are willing and able to offer at different prices, with other conditions held constant. Higher selling prices ordinarily encourage additional output because production that previously failed to cover incremental costs can become worthwhile.
A conventional diagram places price vertically and quantity horizontally, so changes in the product's own price move along an existing demand or supply curve.
- A seller's price reduction increases quantity demanded along the existing demand curve when other conditions remain unchanged.
- A change in customer income, preferences, expectations, or substitute prices shifts demand because customers want different quantities at each possible price.
- Changes in input costs, production technology, taxes, or supplier availability shift supply because production opportunities change at each possible selling price.
Common mistakes
- Wrong curve. A product's price rising from $20 to $22 produces movement along its demand curve when other determinants remain unchanged.
- Discarding every sign. Income elasticity of indicates an inferior good; converting it to positive 0.6 loses the relevant classification.
- Revenue mistaken for profit. In the output table, $30 revenue produces $0 profit, while $20 revenue produces $2 profit.
Bottom line
- Own-price changes cause movements along curves; changes in other determinants shift demand or supply.
- Elasticity compares percentage responses; demand magnitude informs revenue effects, while income and cross-price signs identify economic relationships.
- Profit maximization compares marginal revenue with marginal cost and can select lower revenue than revenue maximization.
- Expansion runs from trough to peak, while recession runs from peak to trough.
Exam shortcut
Identify the changed variable before choosing a curve shift. Separate the product's own price from input prices, income, and substitute prices. Label an elasticity calculation's numerator and denominator before dividing. Preserve signs for income and cross-price questions; classify price-demand responsiveness using magnitude. For a cycle question, distinguish the indicator's direction from its timing. Initial claims and the unemployment rate are different series.
The full lesson (about 5,183 words, 35 min read) adds 2 worked examples, all 5 common mistakes, a self-check, free in the app.
Learning objectives
- II.B1
Browse all free CPA AUD lessons or jump into free CPA AUD practice questions.