Assumptions of Law of Supply


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There are many other factors that affect the supply of a commodity such as the price of related goods, cost of production, level of technology, government policies, etc. The supply curve has a positive gradient, which implies it is an upward sloping curve. As the price of a product goes on to increase, the quantity supplied increases as well. The demand curve, on the other hand, is a downward sloping curve. As the price of a product goes on to decrease, the quantity demanded decreases as well.

When a firm discovers a new technology that allows it to produce at a lower cost, the supply curve will shift to the right as well. For instance, in the 1960s, a major scientific effort nicknamed the Green Revolution focused on breeding improved seeds for basic crops like wheat and rice. A technological improvement that reduces costs of production will shift supply to the right, causing a greater quantity to be produced at any given price. The law of supply and demand can provide a useful model for understanding and determining pricing. It can help determine an equilibrium price, where suppliers can meet demand without overstocking, and customers get everything they need at a price they can accept.

A manager might choose a more expensive vendor for personal reasons, for example, or because they don’t know that a cheaper competitor exists. Figuring out the most optimal choices may also cost more in time and resources than it would save. Under this assumption, a company tries to get the best deal from its vendors to make its product. The idea is that the company exhausts its best options first.

assumptions of law of supply

The opposite is true if the price of video game systems decreases. The company might supply 1 million systems if the price is $200 each, but if the price increases to $300, they might supply 1.5 million systems. When the price of a assumptions of law of supply commodity increases, the seller increases the quantity supplied. The profit of seller increases and the aim of seller is to profit maximization. Further, the law assumes that there are no changes in the prices of other products.

The law of supply states that the relationship between price and supply of a product. It is assumed that transport facilities and transport costs are unchanged. Otherwise, a reduction in transport cost implies lowering the cost of production, so that more would be supplied even at a lower price. By seeing the diagram the conclusion can be drawn that when price rises supply increases and when the price reduces the supply reduces. It describes seller’s supply behaviour under given conditions.

Exceptions to the Law of Supply

In the above figure, the upward sloping line represents the supply line or supply curve of the firm. Different five combinations of price-quantity in the figure show price in the market and corresponding quantity supply of the product. The positively sloping curve depicts the direct relationship between price and supply. The graph below summarizes factors that change the supply of goods and services. Notice that a change in the price of the product itself is not among the factors that shift the supply curve. A supply curve shows how quantity supplied will change as the price rises and falls, assuming ceteris paribus—no other economically relevant factors are changing.

  • The law of supply is a theory in economics that indicates a direct relationship between price and supply.
  • Backward slopping supply curve BS ‘ part represents supply curve is bending at B.
  • Why such situation because workers normally prefer leisure to work after receiving a certain amount of wage.
  • The opposite is true if the price of video game systems decreases.
  • Change in Technology Change in technology also affects supply of the commodity.

But you can imagine short term scenarios like, for example, a natural disaster, that has an effect similar to making technology decrease. In Puerto Rico, the electric grid was wiped out by hurricane, and for many months people have had to make do without the “technology” of electricity. But this isn’t really a decrease in technology – we know how to fix the grid.

Why Is the Law of Supply and Demand Important?

The equilibrium quantity and price are determined on the basis of the intersect point of the demand and supply curves. 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. So higher the price, the greater is the incentive for the producer to produce and supply more in the market, other things remain the same. • Positive slope of supply curve is also caused by the rise in the cost of production.

assumptions of law of supply

Assumptions of the Law of Supply • There is no change in the prices of the factors of production. • Producers do not expect change in the price of the commodity in the near future. Government Policy ‘Taxation and Subsidy’ policy of the government affects market supply of the commodity. On the other hand, subsidies tend to increase supply of the commodity. If supply remains constant and demand increases, prices will rise. If supply remains constant and demand decreases, prices will fall.

What is price elasticity of demand?

For example, a business will make more of a good if the price of that product increases. So, if the price of TVs increases, TV producers are incentivized to produce more of them. Likewise, other companies may be induced to start producing TVs. This will increase the overall supply of televisions in the market. At some point, the abundant supply will tend to cause prices to moderate and fall.

In economically backward countries, production and supply cannot be increased with rise in price due to shortage of resources. Supply signifies the activities of the sellers who purchase products from the manufacturers and sell them in the market to the consumers. The supply depends on the demand response of the consumers and the revenue generated from sold goods. Therefore, if there is a rise in the price, the supply also increases, giving sellers a chance to make more money. The demand curve is a graphical representation of the relationship between the price of a good and the quantity demanded.

When the price of a specific commodity increases, potential producers are encouraged to enter the market and produce the good to make money. The market supply rises as the number of businesses increases. However, once the price begins to decline, some businesses that do not anticipate making any money at a low price may stop production or cut it back.

Higher costs decrease supply for the reasons discussed above. Both the law of supply and the law of demand are based on certain basic assumptions. The factors that affect the demand for a product and the supply of a product are assumed to be constant. The law of demand assumes certain factors remain constant. The relationship between quantity demanded and price of the product is studied by keeping these factors fixed.

The positive sign represents direct relationship between P and Qs. Auction can take place due to various reasons, for instance, a bank may auction the assets of a customer in case of his failure in paying off the debts over a period of time. For example, there would be a decrease in the supply of labour in an organisation when the rate of wages is high. There should not be any change in the income of the purchaser or the seller. Enotes World is an online study portal where you find different study materials on different content.

assumptions of law of supply

Like demand curves, supply curves consider the effect of pricing but assume that everything else remains constant. However, other factors, such as production costs, can affect the supply. Other constraints, such as limits on manufacturing capacity or the availability of raw materials, may also negatively impact the ability to increase supply. Government policies can affect the cost of production and the supply curve through taxes, regulations, and subsidies. For example, the U.S. government imposes a tax on alcoholic beverages that collects about $8 billion per year from producers.

As the number of businesses in the market declines, it decreases the supply of the given commodity. Higher the price, higher will be quantity supplied and lower the price smaller will be quantity supplied. ‘Other things remaining the same’ means determinants other than own price such as technology, goals of the firm, government policy, price of related goods etc. should not change. The law of supply predicts a positive relationship between pricing and supply. Seeing a greater potential for profits, new suppliers may also enter the market. For example, prices of lithium and other metals used in batteries have soared as sales of electric vehicles have increased.

The law of supply is also based on the assumption of ceteris paribus i.e., other things remaining the same assumptions. The law of supply to operate these other factors except its price should hold constant or unchanged. The law of supply or supply hypothesis gives us the relationship between price and quantity supply of the commodity. It means the law of supply shows that higher the price, the larger is the quantity supply; and lowers the price; the smaller is the quantity supply. Therefore, as per the law of supply, the quantity supply is positively related to the price of the product. Price of the Factor of Production Supply of a commodity is also affected by the price of factors used for the production of the commodity.

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Erika Rasure is globally-recognized as a leading consumer economics subject matter expert, researcher, and educator. She is a financial therapist and transformational coach, with a special interest in helping women learn how to invest. Where c and d are parameters while P and Qs are independent and dependent variables, respectively.

The ceteris paribus assumption

If price of a commodity decreases and cost of production also decreases, at the same time, the quantity supplied does not decrease and profit remains constant. A rise in price induces the prospective producers to enter into the market to produce the given commodity so as to earn higher profits. However, as the price starts falling, some firms which do not expect to earn any profits at a low price either stop the production or reduce it. It reduces the supply of the given commodity as the number of firms in the market decreases. The law of supply and demand outlines the interaction between a buyer and a seller of a resource. It incorporates both the law of supply and the law of demand.

This is often because they switch to other goods as replacements. If supply increases and demand stays the same, prices will fall. Responding to rising demand, Earth-Kind created the first all-natural indoor rodent repellent approved by the FDA. Streamlining business operations with an integrated ERP system helped the company maintain a 40% growth rate and increase the supply of its products to 20,000 retail locations. A shortage can occur if the demand for a product increases but the supply doesn’t — or if demand increases faster than production can ramp up.

As such, the law remains valid only as long as other factors affecting the market inventory of goods and services remain constant. Demand-supplySupply has a direct relationship with the price. Thus, if the price rises, the product’s supply will also increase, and if the price falls, then supply will also decrease. In contrast, demand has an indirect relationship with price.

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