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Chapter 3
Demand and Supply
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
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  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
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  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
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
• They determine the price and quantity of a
good or service transacted in a perfectly
competitive market
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PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
3-4
Demand
• The various amounts of a product that
consumers are willing and able to
purchase at various prices during
some specific period
• Demonstrated by demand schedule
and demand curve
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PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
3-5
Law of Demand
• The inverse relationship between the
price and the quantity demanded of a
good or service during some period of
time
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
3-6
Law of Demand (cont.)
Based on:
1. Common sense and observation
2. Diminishing marginal utility
3. Income and substitution effects
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PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
3-7
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
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PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
3-8
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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PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
3-9
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
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PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
3-10
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  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
3-11
Demand
Price
per unit
a
b
c
d
e
Quantity demanded
per week
5
4
3
2
1
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PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
10
20
35
55
80
3-12
Graphing Demand
P D1
a
5
Price ($ per unit)
b
4
c
3
d
2
e
1
0
D1
10
20 30 40 50 60 70 80
Quantity demanded (units per week)
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
Q
3-13
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  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
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
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PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
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
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
3-16
Increase in Demand
P5
D1 D2
Price ($ per unit)
4
3
Increase in
Demand
2
1
0
D1
10
20
30 40 50 60 70
Quantity demanded
80
D2
Q
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
3-17
Decrease in Demand
P5
Price ($ per unit)
4
D1
Decrease in
Demand
D3
3
2
1
0
D3
10
20
30 40 50 60 70
Quantity demanded
80
D1
Q
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
3-18
Changes in Demand
• Tastes or preferences
• Number of buyers
• Income
–
Normal or superior goods—demand varies
directly with income
–
Inferior goods—demand varies inversely with
income
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PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
3-19
Changes in Demand (cont.)
• Prices of related goods
–
Substitute goods
–
Complementary goods
–
Independent goods
• Expectations
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PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
3-20
Changes in Quantity
Demand
• caused by changes in price only
• represented as movement along a
demand curve
• other factors determining demand are
held constant
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PPTs t/a Macroeconomics 7/e by Jackson and McIver
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3-21
Movement along a Curve
P5
D1
Price ($ per unit)
4
Movement along
a demand curve
3
Change in
quantity demanded
2
1
0
D1
10
20
30 40 50 60 70
Quantity demanded
80
Q
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
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  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
3-23
Law of Supply
• Direct relationship between the price
and quantity supplied
• Increased price causes increased
quantity supplied
• Decreased price causes decreased
quantity supplied
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
3-24
Law of Supply (cont.)
Based on:
• Common sense and observation
• Price as revenue per unit
• Rising costs and declining productive
efficiency
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PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
3-25
Market Supply
a
b
c
d
e
Price
Quantity supplied
per unit($)
per week
5
4
3
2
1
12 000
10 000
7 000
4 000
1 000
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
3-26
Supply Curve
P
a
5
b
4
Price ($ per unit)
S1
c
3
d
2
e
1
S1
0
2
4
6
8 10 12 14 16
Quantity supplied (000/week)
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
Q
3-27
Change in Supply
• represented as a shift of the supply
curve
• caused by changes in determinants of
supply other than price
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
3-28
Increase in Supply
P
S1
5
S2
Price ($ per unit)
4
3
2
1
S1
0
2
S2
4
6
8 10 12 14
Quantity supplied (000/week)
16
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
Q
3-29
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)
16
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
Q
3-30
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  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
3-31
Changes in Quantity
Supplied
• Caused by changes in price only
• Represented as a movement along a
supply curve
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
3-32
Movement along a Supply Curve
P
S1
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)
16
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
Q
3-33
Movement along a Supply Curve
P
S1
$5
Price ($ per unit)
4
3
Movement along
a supply curve
2
1
0
S1
2
4
6
8 10 12 14
Quantity supplied (000/week)
16
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
Q
3-34
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
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
3-35
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)
16
18
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
Q
3-36
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)
16
18
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
Q
3-37
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)
16
18
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
Q
3-38
Shortage (Excess Demand)
• Occurs when the quantity demanded
exceeds the quantity supplied at the
current price
• Competition amongst buyers
eventually bids up the price until
equilibrium is reached
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PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
3-39
Surplus (Excess Supply)
• Occurs when the quantity supplied
exceeds the quantity demanded at the
current price
• Competition amongst producers
eventually causes the price to decline
until equilibrium is reached
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PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
3-40
Changes in Demand and
Supply
• 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
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PPTs t/a Macroeconomics 7/e by Jackson and McIver
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3-41
Increase in Demand
P
D1 D2
S
Equilibrium
price & quantity
rise
D2
D1
0
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PPTs t/a Macroeconomics 7/e by Jackson and McIver
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Q
3-42
Decrease in Demand
P
D2 D1
S
Equilibrium
price & quantity
fall
D1
0
D2
Q
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PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
3-43
Increase in Supply
P
D1
S1
S2
Equilibrium
price falls & quantity
rises
S1
S2
D1
0
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PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
Q
3-44
Decrease in Supply
P
D1
S2
S1
Equilibrium
price rises & quantity
falls
S2
S1
D1
0
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PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
Q
3-45
Both Demand & Supply Increase
P
D1 D2
S1
S2
Equilibrium
quantity rises &
price rises
are uncertain
S1
S2
D2
D1
0
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
Q
3-46
Resource Market
• Apply the concept of demand and
supply in a competitive resource
market
• Supply curve for a resource is upwardsloping
• Demand curve is down-sloping
• Direct relationship between resource
price and quantity supplied
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PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
3-47
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 floating exchange rate, the
equilibrium exchange rate is
determined by forces of supply and
demand for a country’s currency
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3-48
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
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
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
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
Q
3-50
Determinants of Exchange
Rates
• Changes in tastes
• Relative income changes
• Relative price changes
• Relative real interest rates
• Speculation
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
3-51
Next Chapter:
Australia’s National and
International Accounts
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
3-52