The law of supply and its determinants
The law of supply and its determinants plays an important role for the producer. Remember, now you think of yourself as a producer and not a consumer. Think as if you are producing a commodity for the market. In this post I will be discussing the following topics:
- The law of supply
- Assumptions to the law of supply
- Factors affecting supply
- Exceptions to the law of supply
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Now, I hope you are thinking from producer point of view. Let’s learn.
The Law of supply
This law states that keeping other things or other factors constant, there exists a direct relationship between the price of a commodity and its quantity supplied. In short, if the price increases, the quantity supplied will be increased, and if the price decreases, the quantity supplied will be decreased.
Assumptions to the law of supply
- There is no change in the price of factors of production.
- Technology remains the same.
- The price of related goods remain the same.
- The tax structure should remain the same.
- Input prices of the price of factors of production should remain the same.
I will be explaining each of the assumption mentioned above.
Tip to remember these assumptions: use the acronym, ‘FITTR’ 💪
F – Factors of production price
I – Input price
T – Tax structure
R- Related goods prices
Factors affecting supply
1. Price of the commodity
This is the exact law of supply, this means, there is a direct relationship between the own price of the commodity and its quantity supplied. The higher the price, the higher will be the quantity supplied. Similarly, the lesser the price, the lesser will be the quantity supplied.
Because more price gives more revenue to the producer and more revenue means more profit.
2. Price of related goods
In this, we will study 2 types of goods:
a. Substitute Goods
The price of a particular commodity is indirectly related to the price of its substitute goods. I hope you remember substitute goods, which can replace each other like wheat and rice.
For example, the supply of wheat will fall when the price of rice increases. Because, if the price of rice is increased, then the producer will be producing more rice, and earn more revenue from the higher price. This will also cause a lower supply of wheat because its price is unchanged. Whereas, rice is more lucrative for the producer to sell.
b. Complementary Goods
The price of a particular commodity is directly related to the price of its complementary goods. Complementary goods are those which are consumed together like cars and petrol.
For example, with the increase in the price of petrol, the supply of cars will increase because producers are aware that petrol is used in cars. So increasing the supply of cars will ultimately benefit the producer. The supply curve for the car will shift to the right.
With the improvement in technology, the producer’s cost of production will ultimately fall for producing more commodities and the supply will increase and the vice versa
4. Input Price
Input price or raw material price or the price of factors of production are the same. If the price of input increases, the cost of production will increases. So, the supply will decrease, and vice versa.
5. Tax structure
Taxes are imposed by the government on the sale and purchase of commodities. This type of tax is an indirect tax as it is levied on commodities and not on the income of the producer or of the consumer.
With the increase in taxes on the sale of goods, the seller will supply less of that commodity because he needs to bear the cost of taxation.
Exceptions to the law of supply
There are some cases when the law of supply does not operate:
1. Agricultural Goods
The Law of supply does not apply to agricultural goods, as their supply depends on natural conditions and not on price.
2. Perishable Goods
Perishable goods include fruits, vegetables, milk, etc. which cannot be held or stored for a long time. The law of supply does not apply to perishable goods because these goods can be supplied even when the prices are low.
3. Antique Goods
Antique goods are rate articles like paintings, which are highly-priced. The Law of supply does not apply on antique goods, because there supply can no be increased even when the price are high.
You can read the related concepts:
- The supply curve
- What is production function?
- Terms related to production concept
- Law of diminishing returns to a factor
- Total cost, Total variable cost and Total fixed cost
- The relation between TC, TVC and TFC
- Average total cost
- The demand curve
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