What is the Law of Supply?
The law of supply is a basic principle in economics that asserts that, assuming all else being constant, an increase in the price of goods will have a corresponding direct increase in the supply thereof. The law works similarly with a decrease in prices.
The law of supply depicts the producer’s behavior when the price of a good rises or falls. With a rise in price, the tendency is to increase supply because there is now more profit to be earned. On the other hand, when prices fall, producers tend to decrease production due to the reduced economic opportunity for profit.
Law of Supply formula
QxS = QxS = Φ (Px)
- QxS – Quantity supplied of commodity/good x by the producers
- Φ – Function of
- Px – Price of commodity/good x
What are the limitations and factors affecting the Law of Supply?
The overarching relationship is between price and quantity, and applies only if all other factors remain constant. There are other factors that can affect the quantity supplied of a given. The following are some of the more common factors:
- Cost of Production – When there are changes in the cost of raw materials or labor to produce a unit of supply, the volume will change as well, assuming the selling price remains the same. The variable cost affecting profit margins is a big factor in targeting the quantity to produce.
- Technological Changes – Advancement in technology can boost the efficiency with which units are produced, lessening the cost of production. This then has a similar effect to that outlined under “Cost of Production”.
- Taxes – The imposition of taxes in the production of goods limits profitability. If a producer is required to remit a portion of sales as tax, then the producer will be less inclined to increase supply.
- Legislations – Certain regulatory laws or quotas may be put in place that limit the quantity of a given product that can be produced. For example, in the energy industry, carbon offsets limit the amount certain companies can supply.
- Periods of Uncertainty – In situations of higher business risk, producers may be inclined to reduce supplies so that they can offload older inventory. During war or civil unrest, for example, producers are more than eager to sell, even possibly at a lower price.
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