Chapter 3
Demand and supply
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics by Jackson and McIver
Slides prepared by Muni Perumal
3-1
Learning objectives
• Examine the nature of markets
• Carefully develop the concepts of demand
and supply
• Discuss the separate factors that lead to shifts
in the demand and supply curves
• Explain how prices and output are determined
in both the product and resource markets through
the interaction of demand and supply
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics by Jackson and McIver
Slides prepared by Muni Perumal
3-2
Learning objectives (cont.)
• Discuss the rationing function of prices and
their role in resource allocation
• Apply the concepts of demand and supply
to the determination of the equilibrium
exchange rate between nations’ currencies
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics by Jackson and McIver
Slides prepared by Muni Perumal
3-3
Markets
• A market is any institutional structure, or mechanism
that brings together buyers and
sellers of particular goods and services
• Markets exists in many forms: local, national,
international, face-to-face
• Markets determine the price and quantity of
a good or service transacted in a perfectly
competitive market
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics by Jackson and McIver
Slides prepared by Muni Perumal
3-4
Demand
• The various amounts of a product that
consumers are willing and able to purchase
at various prices during some specific period
of time
• Demonstrated by demand schedule and
demand curve
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics by Jackson and McIver
Slides prepared by Muni Perumal
3-5
Law of demand
•
•
The inverse or negative relationship between
the price and the quantity demanded of a good
or service during some period of time
Other things being equal or constant assumption
is crucial in this definition
The law of demand is based on:
1. Common sense and simple observation
2. Diminishing marginal utility
3. Income and substitution effects
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics by Jackson and McIver
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3-6
Diminishing marginal utility
• States that successive units of a given product yield
less and less extra satisfaction
• Therefore, consumers will only buy more
of a good if its price is reduced
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics by Jackson and McIver
Slides prepared by Muni Perumal
3-7
Substitution effect
• At a lower price, consumers have the incentive
to substitute the cheaper good for similar goods that
are now relatively more expensive
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3-8
Income effect
• At a lower price, consumers can buy more
of a product without giving up other goods
• A decline in price increases the purchasing
power of money/real income
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics by Jackson and McIver
Slides prepared by Muni Perumal
3-9
Demand curve
• Shows the inverse relationship between price
and quantity demanded for a good or service
• Derived from a demand schedule showing
the quantity demanded at various prices
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics by Jackson and McIver
Slides prepared by Muni Perumal
3-10
Demand
Price
per unit
a
b
c
d
e
5
4
3
2
1
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics by Jackson and McIver
Slides prepared by Muni Perumal
Quantity demanded
per week
10
20
35
55
80
3-11
Graphing demand
P d
5
a
Price ($ per unit)
b
4
c
3
d
2
e
1
0
d
10
20 30 40 50 60 70 80
Quantity demanded (units per week)
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics by Jackson and McIver
Slides prepared by Muni Perumal
Q
3-12
Individual and market demand
• Market demand is derived by horizontally
summing individual demand curves
• Market demand is derived by adding all
the quantities demanded in a demand
schedule which correspond to their prices
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics by Jackson and McIver
Slides prepared by Muni Perumal
3-13
The market demand curve is the sum
of the individual demand curve
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics by Jackson and McIver
Slides prepared by Muni Perumal
3-14
Determinants of demand
• Major determinants of market demand apart
from the price of the product
• Tastes or preferences of consumers
• The number of consumers
• Income of consumers
• Prices of related goods
• Expectations about future prices and income
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics by Jackson and McIver
Slides prepared by Muni Perumal
3-15
Changes in demand
• Caused by changes in other determinants
of demand
• Represented as a shift of the demand curve
either to the right or left
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PPTs t/a Macroeconomics by Jackson and McIver
Slides prepared by Muni Perumal
3-16
Increase in demand
P5
D1 D2
Increase in
Demand
Price ($ per unit)
4
a
3
b
2
1
Movement along
a demand curve
0
10
20
30 40 50 60 70
Quantity demanded
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics by Jackson and McIver
Slides prepared by Muni Perumal
D1
80
D2
Q
3-17
Decrease in demand
P5
D1
D3
Price ($ per unit)
4
Decrease in
demand
3
2
1
0
D3
10
20
30 40 50 60 70
Quantity demanded
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics by Jackson and McIver
Slides prepared by Muni Perumal
80
D1
Q
3-18
Changes in demand
• A shift in the location of the demand curve
is called a change in demand
• A shift in the demand curve to the right or to
the left occurs when each of the determinants
of demand changes as follows:
• Tastes or preferences
• Number of buyers
• Income
– Normal or superior goods: demand varies
directly with income
– Inferior goods: demand varies inversely with income
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics by Jackson and McIver
Slides prepared by Muni Perumal
3-19
Changes in demand (cont.)
• Prices of related goods
– Substitute goods: there is a direct relationship
between the price of one good and the demand
for another
– Complementary goods: there is an indirect
relationship between the price of one good and
the demand for another
– Independent goods: a change in the price of one
good will have negligible impact on the demand
for the other
• Consumer expectations
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics by Jackson and McIver
Slides prepared by Muni Perumal
3-20
Changes in quantity demand
• A ‘change in demand’ versus a ‘change
in the quantity demanded’
• A change in the quantity demanded is caused
by changes in the price of the good or service only
• Represented as movement along a demand curve
• Other factors determining demand are held constant
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics by Jackson and McIver
Slides prepared by Muni Perumal
3-21
Graphical summary of determinants of
demand
Copyright  2007 McGraw-Hill Australia Pty Ltd
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Slides prepared by Muni Perumal
3-22
Supply
• The various amounts of a product that producers are
willing and able to supply at various prices during
some specific period
• Demonstrated by the supply schedule and
supply curve
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics by Jackson and McIver
Slides prepared by Muni Perumal
3-23
Law of supply
• Shows the direct relationship between the price and
quantity supplied
• Increased price causes increased quantity supplied
• Decreased price causes decreased quantity supplied
Based on:
• Common sense and observation
• Price as revenue per unit and an incentive
to produce and sell a product
• Rising costs and declining productive efficiency
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics by Jackson and McIver
Slides prepared by Muni Perumal
3-24
An individual producer’s supply
of product X
a
b
c
d
e
Price
Quantity supplied
per unit ($)
per week
5
4
3
2
1
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics by Jackson and McIver
Slides prepared by Muni Perumal
60
50
35
20
5
3-25
Change in supply
• Represented as a shift of the supply curve
• Caused by changes in determinants of supply other
than price
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics by Jackson and McIver
Slides prepared by Muni Perumal
3-26
Increase in supply
P
S1
5
S2
Price ($ per unit)
4
3
2
1
0
S1
2
S2
4
6
8 10 12 14
Quantity supplied (000/week)
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics by Jackson and McIver
Slides prepared by Muni Perumal
16
Q
3-27
Decrease in supply
P
S3
5
S1
Price ($ per unit)
4
3
2
1
0
S3
S1
2
4
6
8 10 12 14
Quantity supplied (000/week)
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics by Jackson and McIver
Slides prepared by Muni Perumal
16
Q
3-28
Determinants of supply
• Resource price
• Technology
• Prices of other goods
• Expectations
• Number of sellers
A change in any of these determinants will shift
the supply curve to the left or right
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics by Jackson and McIver
Slides prepared by Muni Perumal
3-29
Changes in quantity supplied
• Caused by changes in price only
• Represented as a movement along a supply curve
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics by Jackson and McIver
Slides prepared by Muni Perumal
3-30
Movement along a supply curve
P
S
1
5
Price ($ per unit)
4
3
Movement along
a supply curve
2
1
0
S1
2
4
6
8 10 12 14
Quantity supplied (000/week)
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics by Jackson and McIver
Slides prepared by Muni Perumal
16
Q
3-31
Movement along a supply curve
P
S
1
$5
Price ($ per unit)
4
3
Movement along
a supply curve
2
1
0
S1
2
4
6
8 10 12 14
Quantity supplied (000/week)
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics by Jackson and McIver
Slides prepared by Muni Perumal
16
Q
3-32
Graphical summary of determinants of
demand
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics by Jackson and McIver
Slides prepared by Muni Perumal
3-33
Market equilibrium
• Occurs when the buying decisions of households
and the selling decisions of producers are equated
• Determines the equilibrium price and equilibrium
quantity bought and sold in the market
• The intersection of the supply curve and the
demand curve indicates the equilibrium point
• Competitive forces where supply and demand
are synchronised are called the rationing function
of prices
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics by Jackson and McIver
Slides prepared by Muni Perumal
3-34
Market equilibrium (cont.)
P
S
Price ($ per unit)
5
4
Equilibrium price
3
2
1
0
D
2
4
6 7 8 10 12 14
Units of X (000/week)
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics by Jackson and McIver
Slides prepared by Muni Perumal
16
18
Q
3-35
Market equilibrium (cont.)
P
Price ($ per unit)
5
surplus
S
4
Equilibrium price
3
2
1
0
D
2
4
6 7 8 10 12 14
Units of X (000/week)
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics by Jackson and McIver
Slides prepared by Muni Perumal
16
18
Q
3-36
Market equilibrium (cont.)
P
Price ($ per unit)
5
surplus
S
4
Equilibrium price
3
2
shortage
1
0
D
2
4
6 7 8 10 12 14
Units of X (000/week)
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics by Jackson and McIver
Slides prepared by Muni Perumal
16
18
Q
3-37
Shortage (excess demand)
• Occurs when the quantity demanded exceeds
the quantity supplied at the current price
• Competition among buyers eventually bids
up the price until equilibrium is reached
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics by Jackson and McIver
Slides prepared by Muni Perumal
3-38
Surplus (excess supply)
• Occurs when the quantity supplied exceeds
the quantity demanded at the current price
• Competition among producers eventually causes the
price to decline until equilibrium is reached
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics by Jackson and McIver
Slides prepared by Muni Perumal
3-39
Changes in supply and demand
• Changes or shifts will disrupt the equilibrium
• The market will adjust until once again an equilibrium
is reached
• The equilibrium price and quantity traded
will change
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics by Jackson and McIver
Slides prepared by Muni Perumal
3-40
Increase in demand
P
D1 D2
S
Equilibrium
price & quantity
rise
D2
D1
0
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PPTs t/a Macroeconomics by Jackson and McIver
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Q
3-41
Decrease in demand
P D2 D1
S
Equilibrium
price & quantity
fall
D1
D2
0
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics by Jackson and McIver
Slides prepared by Muni Perumal
Q
3-42
Increase in supply
P
D1
S1
S2
Equilibrium
price falls & quantity
rises
S1
S2
0
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Slides prepared by Muni Perumal
D1
Q
3-43
Decrease in supply
P
D1
S2
S1
Equilibrium
price rises & quantity
falls
S2
S1
0
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D1
Q
3-44
Both demand & supply increase
P
D1 D2
S1
S2
Equilibrium
quantity rises
&
price rises
are uncertain
S1
S2
0
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics by Jackson and McIver
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D2
D1
Q
3-45
Resource market
• Apply the concept of demand and supply
in a competitive resource market
• Supply curve for a resource is upward-sloping
reflecting the direct relationship between resource
price and quantity supplied
• Demand curve is down-sloping
• Direct relationship between resource price
and quantity supplied
• The supply decisions of households and
the demand decisions by firms in a competitive
market determine the price of resources
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3-46
Foreign exchange market
• The exchange rate is the rate at which a unit
of a country’s currency is exchanged for currency
of another nation
• Under a floating exchange rate, the equilibrium
exchange rate is determined by forces of supply and
demand for a country’s currency
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3-47
Depreciation and appreciation
• Depreciation means, it takes more units
of a country’s currency to buy a single unit
of a foreign currency
• Appreciation means it takes fewer units
of a country’s currency to buy a single unit
of a foreign currency
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3-48
Equilibrium exchange rate
• Demand for the pound
– Down-sloping because as the pound becomes less
expensive, demand for British goods and the pound
increases
• Supply of the pound
– Up-sloping because as the pound rises in value,
demand for British goods and the pound fall
• Intersection of demand and supply is the Australian
dollar price of the pound
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3-49
Equilibrium exchange rate (cont.)
Aust. dollar price of one pound
P
D0
D1
S1
S1
3
Qo
2
Q1
D1
1
D0
S1
Pounds
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PPTs t/a Macroeconomics by Jackson and McIver
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Q
3-50
Determinants of exchange rates
• Changes in tastes
– Change in consumers taste or preference
for a foreign country’s product
• Relative income changes
– If domestic income rises, import will rise and alter
the exchange rate
• Relative price changes
– Relative changes in inflation between countries
• Relative real interest rates
– Interest rate differentials alter the attractiveness
of financial investment
• Speculation
– Speculators expectation about future currency
changes
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics by Jackson and McIver
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3-51