Law of Supply

Suppliers adjust their volume based on price

What is the Law of Supply?

The law of supply is a basic principle in economics that, assuming all else are constant, an increase in price of goods will have a corresponding direct increase in the supply thereof. This works similarly for a decrease. This depicts the producer’s behavior that when the price of a good rises, his tendency to supply increase because there is now more profit to be earned. On the other hand, when prices fall, the producer will decrease production due to a reduced economic opportunity.

Formula

QxS = QxS = Φ (Px)

Where:

  • QxS – Quantity supplied of commodity x by the producers
  • Φ – Function of
  • Px – Price of commodity 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 price of a given item, and thus the quantity supplied. These are some of the more common factors:

  • Cost of Production – when there are changes in the cost of raw materials and 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 by which units are produced, lessening cost of production. This would have a similar effect as outlined under ‘Cost of Production’.
  • Taxes – imposition of taxes in the production of goods limits the profitability of a commodity. Similarly, if a producer is required to remit a portion of sales as tax, a producer will be less inclined to up supply.
  • Legislations – certain regulatory laws or quotas may be put in place that limits the quantity of a given product. For example, in the Energy industry, carbon offsets limit the amount certain companies can supply.
  • Periods of Uncertainty – In situations of higher risk, producers may be more open to lower supplies so they can offload their inventory. During war and civil unrest, for example, producers are more than eager to sell at a lower price.

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