What is the law of supply?
The law of supply is the microeconomic law which states that, all other factors being equal, as the price of a good or service increases, the quantity of goods or services offered by suppliers will increase and vice versa. The law of supply indicates that as the price of an item increases, suppliers try to maximize their profits by increasing the quantity offered for sale.
Key points to remember
- The law of supply stipulates that a higher price will encourage producers to supply more on the market.
- Supply in a market can be described as an upwardly sloping supply curve which shows how the quantity supplied will respond to various prices over a period of time.
- Because companies seek to increase their revenues, when they expect to receive a higher price, they produce more.
Understanding the law of supply
The graph below illustrates the law of supply using an upward sloping supply curve. A, B and C are points on the supply curve. Each point on the curve reflects a direct correlation between the quantity supplied (Q) and the price (P). Thus, at point A, the quantity supplied will be Q1 and the price will be P1, and so on.
The supply curve is on an upward slope because, over time, suppliers can choose the quantity of their products to be produced and subsequently marketed. However, at some point, the supply that sellers place on the market is fixed, and sellers are simply faced with the decision to sell or hold back their stock from a sale; consumer demand sets the price and sellers can only charge what the market will bear. If consumer demand increases over time, the price will rise and suppliers may choose new production resources (or new suppliers may enter the market), which increases the quantity supplied. Demand ultimately defines the price in a competitive market, the supplier’s response to the price it can expect fixes the quantity supplied.
The law of supply is one of the most basic concepts of economics. It works with the law of demand to explain how market economies allocate resources and determine the prices of goods and services.
Practical examples of how supply works
The law of supply summarizes the effect of price changes on the behavior of producers.
For example, a company will manufacture more video game systems if the price of these systems increases. The opposite is true if the price of video game consoles decreases. The company could supply 1 million systems if the price is $ 200 each, but if the price increases to $ 300, it could supply 1.5 million systems.
To further illustrate this concept, let’s consider how gas prices work. When the price of gasoline goes up, it encourages for-profit companies to take several steps: expanding the exploration of oil reserves; drill for more oil; invest in more pipelines and tankers to bring oil to factories where it can be refined into gasoline; build new oil refineries; purchase additional pipelines and trucks to ship gasoline to service stations; and open more petrol stations or keep existing petrol stations open longer.
The law of supply is so intuitive that you may not even know all the examples around you.
- When students learn that computer engineering jobs pay more than English teacher jobs, the supply of students with a major in computer engineering will increase.
- When consumers start paying more for cupcakes than donuts, bakeries will increase their production of cupcakes and reduce their production of donuts to increase profits.
- When your employer pays time and a half for overtime, the number of hours you are willing to work is increased.