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Law of supply states quantity supplied of good has a positive correlation with its own-price, ceteris paribus. If the price of a product rises, the quantity supplied will increase. A higher price encourages producers to increase output to get more profits. But, if the price of goods goes down, the quantity supplied will fall.
If you plot for each price and quantity, the relationship between the two will form a supply curve. The curve has a positive slope, which means there is a positive relationship between quantity supplied and price.
The law of supply is one of the basic principles of economic theory besides the law of demand.
What is the rationality behind the law of supply?
The law shows you, producers are pleased when prices are higher. It was a signal for them to make more sales and profits. They will then increase production.
For example, when world oil prices rise, producers see a higher profitability prospect. They then expanded exploration and drilling to produce more oil. As a result, oil supply increases.
The opposite situation applies. When prices fall, it becomes a signal for producers to reduce production. Lower price means less profit.
Why assume other factors remain constant?
The producers’ willingness to supply goods to the market depends not only on the own-price of a good. Several other factors also affect supply, including:
- Production capacity
- Input prices, such as raw materials and labor
- Technology
- Prices of related goods
- Number of producers
- Production subsidies
- Tax
- Input availability
- Weather and other natural disasters
If those factors change, the law of supply is inapplicable. Say, the price of a good goes up by 5%. But, at the same time, producers face a wage increase of 9%.
They may rethink when they want to increase production. Marginal costs are higher than marginal income, making the option to increase output is unprofitable.
