Law of Supply

Definition

The law of supply states that, all else equal, as the price of a good or service rises, the quantity supplied of that good or service will increase, and as the price falls, the quantity supplied will decrease. This relationship between price and quantity supplied is the foundation for understanding how markets function.

5 Must Know Facts For Your Next Test

1. The law of supply explains how producers respond to changes in price, with higher prices leading to an increase in quantity supplied and lower prices leading to a decrease in quantity supplied.
2. The law of supply is based on the assumption that producers are motivated by profit, and will increase production when prices rise to take advantage of the higher profit margins.
3. The law of supply is a key concept in understanding how the market system efficiently allocates resources, as it helps explain how prices adjust to balance supply and demand.
4. The law of supply is also important in understanding the concept of price elasticity of supply, which measures the responsiveness of quantity supplied to changes in price.
5. The factors of production, such as land, labor, capital, and entrepreneurship, play a crucial role in determining the quantity supplied of a good or service, as they influence the cost of production and the ability of producers to respond to changes in price.

Review Questions

• Explain how the law of supply relates to the concept of equilibrium in markets for goods and services (Topic 3.1).
  • The law of supply is a fundamental concept in understanding how markets reach equilibrium, where the quantity supplied equals the quantity demanded at a specific price. When there is a change in price, the law of supply dictates how producers will respond by adjusting the quantity they are willing to supply. This change in quantity supplied then interacts with the quantity demanded to determine the new equilibrium price and quantity in the market.
• Describe how the law of supply contributes to the market system's efficiency as a mechanism for information (Topic 4.3).
  • The law of supply, along with the law of demand, allows the market system to efficiently allocate resources by using price as a signal to convey information to both producers and consumers. When there is a change in supply or demand, the resulting change in price provides a clear incentive for producers to adjust their quantity supplied, which then helps the market reach a new equilibrium. This process of price adjustment and the resulting changes in quantity supplied and demanded allows the market to efficiently distribute scarce resources to their highest-valued uses.
• Analyze how the law of supply relates to the concept of price elasticity of supply (Topic 5.1).
  • The law of supply and the concept of price elasticity of supply are closely linked. The law of supply describes the positive relationship between price and quantity supplied, while price elasticity of supply measures the responsiveness of quantity supplied to changes in price. Producers' willingness to increase or decrease production in response to price changes, as described by the law of supply, determines the price elasticity of supply. Goods with a more elastic supply, where producers are more responsive to price changes, tend to have a steeper supply curve, while goods with a more inelastic supply have a flatter supply curve.

Related terms

Supply Curve:

A graphical representation of the law of supply, showing the positive relationship between price and quantity supplied.

Supply Schedule: A table that shows the quantities of a good or service that producers are willing and able to sell at various prices during a given time period.

Factors of Production: The resources, such as land, labor, capital, and entrepreneurship, that are used to produce goods and services.