Law of Supply
The law of supply is the microeconomic law that states that, all other factors being equal, as the price of a good or service increases, the quantity of goods or services that suppliers offer will increase, and vice versa. The law of supply says that as the price of an item goes up, suppliers will attempt to maximize their profits by increasing the quantity offered for sale.
Law of supply states that other factors remaining constant, price and quantity supplied of a good are directly related to each other. In other words, when the price paid by buyers for a good rises, then suppliers increase the supply of that good in the market.
Assumptions of the Law of Supply
Important assumptions of the law of supply are as follows:-
1. No change in the income
There should not be any change in the income of the purchaser or the seller.
2. No change in technique of production
There should not be any change in the technique of production. This is essential for the cost to remain unchanged. With the improvement in technique if the cost of production is reduced, the seller would supply more even at falling prices.
3. There should be no change in transport cost
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.
4. Cost of production be unchanged
It is assumed that the price of the product changes, but there is no change in the cost of production. If the cost of production increases along with the rise in the price of product, the sellers will not find it worthwhile to produce more and supply more. Therefore, the law of supply will be valid only if the cost of production remains constant. It implies that the factor prices such as wages, interest, rent etc., are also unchanged.
5. There should be fixed scale of production
During a given period of time, it is assumed that the scale of production is held constant. If there is a changing scale of production the level of supply will change, irrespective of changes in the price of the product.
6. There should not be any speculation
The law also assumes that the sellers do not speculate about the future changes in the price of the product. If, however, sellers expect prices to rise further in future, they may not expand supply with the present price rise.
7. The prices of other goods should remain constant
Further, the law assumes that there are no changes in the prices of other products. If the price of some other product rises faster than that of the product in consideration, producers might transfer their resources to the other product—which is more profit yielding due to rising prices. Under this situation and circumstances, more of the product in consideration may not be supplied, despite the rising prices.
8. There should not be any change in the government policies
Government policy is also important and vital for the law of supply. Government policies like—taxation policy, trade policy etc., should remain constant. For instance, an increase in or totally fresh levy of excise duties would imply an increase in the cost or in case there is fixation of quotas for the raw-materials or imported components of a product, then such a situation will not permit the expansion of supply with a rise in prices.