Economics Fundamentals: The Law of Supply

The model of demand and supply constitutes one of the most fundamental principles in Economics. In the competitive market, holding all other factors that affect purchase decision-making constant, there are many buyers who are willing and able to buy at a certain price, and many producers who are willing and able to produce at various prices. The correlation between quantity demanded and price is referred to as the demand relationship, while the relationship between the quantity supplied and price is referred to as the supply relationship.

The market supply of goods generally depends on many things. However, when graphing the supply curve all factors are held constant, except the price. Changes in the price of a good lead to a change in the quantity supplied of that good, which corresponds to a movement along a given supply curve. According to the law of supply, price and quantity supplied are directly related and if all other factors that affect market supply are held constant, as the price of a good increases (decreases), the quantity supplied of that good increases (decreases). In other words, producers are willing to produce more output when the price of a particular good is high than when it is low.

Variables other than the price of a good that can influence supply are known as supply shifters. Each variable has a different impact on supply and when a variable changes, it leads to a change in supply. This change is depicted on the supply curve, which is an upward slope that summarizes the total quantities that producers are willing and able to produce at certain prices, holding all other factors that affect supply constant. A rightward shift in the supply curve implies an increase in supply as more quantity is supplied at each given price. A leftward shift in the supply curve implies a decrease in supply as less quantity is supply at each given price.

a)      Input Prices

When production costs change, so does the willingness of producers to produce at a given price. In particular, as the price of an input increases, producers are less willing to produce and the output at any given price decreases. This decrease in quantity supplied is reflected with a leftward shift in the supply curve.

b)      Technology / Government Regulations

Technological changes or changes in government regulations can also affect the position of the supply curve. Changes that can make it possible to produce more output at a lower cost result in the increase of the quantity supplied and a shift of the supply curve to the right. Conversely, changes that have a negative impact on business, lead to the decrease of the quantity supplied and a shift of the supply curve to the left.

c)      Number of Firms

When additional firms enter an industry, more output is produced and is made available to consumers at any given price. This is reflected by a shift of the demand curve to the right. Conversely, if fewer firms operate in the industry, fewer units are supplied at each given price and the quantity supplied decreases, shifting the supply curve to the left.

d)      Substitutes in Production

Firms that possess technological infrastructure and are readily adaptable to several products can increase the quantity supplied when the price of the good increases. For instance, automobile industries can alter their production facilities from a truck assembly line to a car assembly line and produce more cars when required in order to anticipate an increase in the price of cars. This shifts the truck supply curve to the left.

Other factors that may affect the supply are producer expectations and taxes. For instance, if producers expect that future prices will be higher next year and their product is not perishable, they can hold back output today and sell it lat at a higher price. In other words, producers substitute current sales for future sales if they expect future prices to rise. This will shift the current supply curve to the left.

Finally, market supply is influenced by taxes imposed by government. An excise tax, which is a tax imposed on each unit of output sold, will make producers less willing to produce and will decrease the quantity supplied shifting the supply curve to the left.