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Law of Supply


Posted Date: 19-Feb-2010  Last Updated:   Category: Education    
Author: Member Level: Gold    Points: 10


Explanation of Law of Supply; Assumptions of law of supply; Determinants of law of supply; Exceptions to the law of supply; Causes for changes in increase and decrease of supply.



Introduction:
This law is explained by Marshall one of the great economist. He has explained the producers tendency of supplying a commodity in relation to its price. This law establishes a functional relationship between price and quantity supplied of a commodity.

Supply refers to the quantity of commodity the sellers are able and willing to sell at a particular price during a given period of time. It is a part of stock. It can be equal to or less than stock. It is more elastic. For example: 10 tonnes of sugar supplied at Rs.15/- per kg. on a particular day is the supply. It depends upon the nature of the commodity, time period, price level, etc.

Statement of Law:
"Other things being same, quantity supplied of a commodity varies directly with its price". The law of supply establishes a functional relationship between price and quantity supplied that is when the price of a commodity rises, its supply expands and when price falls, it supply reduces. Thus price and supply move in the same direction.

Contraction of Supply:

  • If the supply of a commodity contracts, exclusively due to fall in the price of a commodity when all the other determinants remain constant, then it is known as contraction of supply.

  • Here, price falls, while other determinants like cost of production, government policy etc. remains constant.

  • It can be shown on the supply curve with a downward movement.

Decrease in Supply

  • If the supply of a commodity decreases, due to change in anyone of factors other than the price of the commodity, then it is known as a decrease in supply.

  • Here the price remains constant. Decrease in supply may be due to expensive technique of production or lack of transport facility, etc.

  • It can be shown with the help of a shift in the supply curve towards the left side of the original supply curve.


Assumptions to the Law:
This law is based on the following assumptions as mentioned:

  • Cost of production:
    It is assumed that the price of the product changes without any change in the cost of production. If the cost of production rises along with the rise in the price of the product, it is not profitable for the sellers and they will not sell more quantity.

  • No change in the techniques of production:
    The techniques used in production process should remain constant. This is an important condition to maintain constancy of the cost of production s constant one.

  • Scale of production:
    During the production process, there should not be any change in the scale of production. If there is any change in the scale of production, there will be change in supply, irrespective of the change in the price of the commodity.

  • No changes in Government policy:
    Government policies like taxation, trade policy etc. are assumed to be constant. For example if there is any change in levy tax or change in quota for raw materials or change in the policies regarding export or import of a commodity, then in that case supply cannot be increased with a rise in price.

  • No change in transport cost:
    It is assumed that transport costs are unchanged. Any reduction or increase in transport cost will affect the supply of the commodity without any change in price.

  • No speculation:
    It is assumed that the sellers do not speculate about the future changes in the price of the product. If they expect a rise in price in future, they will not supply more today even if the present price is high.

  • Constancy of price of related goods:
    It is assumed that there are no change in the price of related goods. If the price of other commodity rises much faster than this commodity then the sellers will start producing that commodity by shifting the raw-materials towards the production of that commodity which is a profitable one.

More Determinants:
These are the determinants to the law of supply as follows:

  • Price of the commodity:
    When the price of the commodity rises, supply rises and when the price of the commodity decreases, supply decreases.

  • Price of other commodities:
    The producers will supply those commodities which command high prices and profits.

  • Goals of the producers:Sellers supply the commodity to the market to earn profit, or to capture the market or with the welfare motive. So the different motives of the producers alter supply.

  • State of technology:
    Improvement in technology and methods of production increases supply.

  • Transport facilities:
    When there is adequate transport and communication facilities available supply will be greater and the market will be wider and vice versa.

  • Taxation:
    If heavy taxes are imposed on commodities, supply will reduce and vice versa. If the government provides subsidies to encourage production, supply will increase. Hence, the tax policy of the government affects the supply.

  • Expectation regarding future prices:If the prices are expected to rise in future, supply will be withheld. If the price is expected to fall in the future. there may be a speculative hoarding at present.

  • Time element:
    In the short period, supply is fixed because time is very short for supply to be changed according to the demand as there is ample time for producer to increase the supply by increasing production.


Exceptions to the Law:
The law of supply states the direct functional relationship between supply and price. But in exceptional cases the functional relationship will be inverse.

  • Supply of Labor:
    Labor is an exception to this law. After a certain point with a rise in wage, the supply of labor falls continuously. It is because at higher wages, a person prefers to have more leisure than work. He works less hours per day.

  • Supply of Investment:
    The rate of interest and supply of money for investment or deposit are inversely proportional during certain special cases. For example when a person wants to get an annual interest of Rs.100/-, he has to deposit an amount of Rs. 1000/- if the rate of interest is 10%. If the rate of interest increases to 20% a deposit of Rs.500/- is sufficient for him to get Rs.100/- as an interest.

  • Urgent need for money:
    When a businessmen urgently needs money, he may supply more of a commodity even at a lower price. This is also a case of exception to the law of supply.


So by this we have completed the full portion of the topic Law of Supply

Thank you.


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