Law of Supply

The law of supply in economics suggests that with other factors remaining constant, if the price of a commodity increases, its market supply also goes up and vice-versa. It is one of the fundamental laws in economics. It establishes a direct relationship between the price and supply of a commodity.

Therefore, if there is a rise in the price, the supply also increases, giving sellers a chance to make more money.

• The law of supply is a theory in economics that indicates a direct relationship between price and supply. It suggests that all factors remaining constant, if the price of a commodity increases, it leads to an increase in its market supply and vice-versa. This is because sellers will try to gain maximum profit by increasing sales.
• As opposed to this, the law of demand suggests that the with all things remaining constant, when the price of a commodity increases, it leads to a fall in demand and vice-versa. The reason behind being consumers tend to spend more on normal goods if their price falls down due to greater affordability.
• Supply and demand determine the prices of various goods. The supply law also has an important significance in determining the number of firms operating in a domain. If the price falls too low, many companies stop production.

It is important to note that we are talking about a theoretical idea. In the real world, many other factors also play a huge role in determining demand-supply. For example, when a government levies taxes on certain factors of production, the per-unit cost goes up.

In such a case, the supply will go down to accommodate for the increased costs. As such, the law remains valid only as long as other factors affecting the market inventory of goods and services remain constant.

The law of supply graph is upward sloping, reflecting the direct relationship between price and supply. Let us look at the example below to gain more clarity on this.

Many factors affect the supply in reality, which will lead to a shift in the supply curve. A decrease in supply shifts the curve to the left and vice-versa. For example, when the cost of factors of production decreases, it leads to greater production at the same cost. Resultantly, the supply curve shifts to the right, increasing supply.

However, the changes in the quantity supplied are different from the changes in the supply. This is because the sellers consider factors such as the market price, profit opportunities, consumer demand, etc., before determining the quantity supplied.

When there is a change in the quantity supplied, it causes movements along the supply curve. When the price changes, the supply increases or decreases accordingly, leading to upward or downward movement along the supply curve.

Let us suppose Tom opens a small eatery offering sandwiches, hotdogs, hamburgers, fries, and shakes. After a month of operation, Tom receives a good response.

Every day Tom sells –

1. 50 shakes
2. 45 sandwiches
3. 60 hamburgers
4. 30 fries
5. 120 hotdogs

By word-of-mouth, Tom earns a reputation for serving the best hotdogs, drawing in people from around the city. Responding to the increase in demand, Tom hikes the prices by $1. Tom also increases the supply by making more hotdogs. Reflecting on the example, why do you think Tom increased the cost? 

Tom was already doing well; hiking the price was a risk. But Tom did it anyway, to earn more profit and maximize his gains. Therefore, this law throws light on a seller’s desire to maximize profit and sales in the market. 

• The law of demand and supply together fix the market price of a commodity. The law of demand states that when the price of a commodity increases, its demand falls and vice-versa. Graphically, it is a downward sloping curve indicating the same.
• The law of supply states that when price of a commodity increases, the supply also increases. It is an upward sloping curve.
• The point where these two curves intersect on the graph becomes the equilibrium or the market price of the commodity. In other words, it is the price at which people are willing to buy and the sellers are comfortable to sell the commodity. In the graph above, the equilibrium price is $15.
• The equilibrium takes into account several factors affecting demand and supply. A simple example is sellers lowering price to be able to sell more when there are more sellers in the market, leading to increased supplies. For example, Amazon had lowered the price of Kindle from $259 to $189 in 2010. The sales rose to three times in the first quarter of 2010, as compared to 2009.

This has been a guide to the Law of Supply, meaning, graphs and examples. Here we discuss differences between the law of supply vs. the law of Demand. You may also have a look at the following articles to learn more –

• Law of Diminishing Returns
• Natural Law
• Law of Diminishing Marginal Utility