CA Foundation Exam June 2023 » CA Foundation Study Material » Business Economics » Law of Supply

Law of Supply

The law of supply is an important concept to understand how price is determined in a market. However, there are significant exceptions to this law.

At the core of the microeconomic model of determining market price, lies the law of supply and demand. It is important to understand these two concepts at the onset. Through the law of supply, we can understand what factors work behind the supply of a particular product at a particular point of time in the market, and how it influences the price for the said product. The market price fluctuates until the demanded quantity of a particular product is equal to the supplied quantity of that product at a particular price. For a thorough understanding of which we must first look into the law of supply in economics. 

Law of Supply

According to the law of supply, if all the other factors remain constant, then a rise in the price of a particular product in a market will increase the supply of the product. In other words, the law of supply asserts that in a market the price of a product and its supply has a direct relationship, provided all other factors stay constant. 

This is often exemplified by the supply curve. The supply curve shows what quantity of a product a seller would sell at a given price. If the price goes down, so does the quantity of the product following the law of supply. This happens because the seller needs to cover his expenditure or cost of producing the product, among other things, and then needs to make some profit. If she cannot make any profit at a given price, she won’t be willing to sell the product. 

Factors affecting Law of Supply

Several factors determine the price of a product besides the law of supply in economics. While depicting the law of supply we have assumed that all the other factors remain constant. Now let us quickly look at some of the factors that might affect the supply of a particular product.

  • Production Cost: The production cost includes all the four factors of economics, namely, land, labour, capital, and entrepreneur. Any changes in the cost of these factors will affect the quantity of a product a seller will be willing to sell at a given price.
  • Advancement in Technology: Technological advancements may result in an effective change in the labour required for the production of a particular product. If less labour is required for that production, it will save up a significant amount of labour cost. Hence, that will increase the supply of the given product when the price is constant.
  • Tax: The tax taken by the government for the production of a certain product will eventually affect the supply of that product at a given price. In many cases, the government charges less tax on the production of goods and services it wants to flourish in the country or promote. Changes in tax rates will bring changes in the production and that will eventually affect the supply of that product. 
  • Laws and regulations: There can be a limit to the production of particular products by the law of a country, such as companies producing a large number of greenhouse gases may be limited to a certain amount of production by legal restrictions.
  • Unprecedented Situations: Sometimes there are unprecedented situations like famine, war, or coup d’état in a country. In such unprecedented situations, the supply of a particular product may be significantly affected. 

Exceptions

Sometimes the supply of a product does not share a direct relationship with its market price, hence do not follow the law of supply. The following are some of the exceptions to the law of supply. 

  • Expectation for future price rise: Many a time sellers create artificial scarcity for the expectation of more rise in the future price of a product. This is an exception to the law of supply as the supply doesn’t increase with the price rise.  
  • Perishable Goods: There are various perishable goods, such as vegetables that bear a risk of rotting. Hence, at certain points even if the price decreases the supply increases. 
  • Supply of Labour: Another significant exception to the law of supply is seen in the labour market. After a certain point, more wage does not increase the supply of labour, as labourers will tend to engage in labour more. 
  • Rare or Limited Article: Certain products are rare or cannot be produced again, such as the Kohinoor or a painting by R.N. Tagore, even if the price constantly increases. 

Conclusion

The law of supply and demand are important factors to determine the market price for a particular product. As long as the supply in a market is not equal to the demand the price of the product keeps fluctuating. When they are equal the price reaches equilibrium, meaning the price is fixed, and thus the price is determined in a market. The supply curve is an effective way to understand the law of supply.