Law of Supply and Its Exceptions

Law of Supply

The quantity supplied, other things remaining equal, varies directly with price. The supply of a commodity increases with increase in price and decreases with decrease in price. This tendency is called the law of supply. When the price of a commodity increases, there is an increase in profit. This induces firms to produce and sell more quantity.

The law that supply varies directly with the price is based on several assumptions:
  1. There is no change in the price of substitutes.
  2. There is no change in the cost of factors of production.
  3. There is no expectation of any change in prices in future.
The law of supply can be explained by the help of supply schedule presented below:
Supply Schedule
Price ($ per kg)
Quantity Supplied (kg. per month)
2
4
6
8
10
12
1
10
20
30
35
37

As shown in table, when price is $2 per kg, the quantity supplied is 1kg. When price increases to $4, quantity supplied increases to 10kg. Likewise when price increases to $6, quantity supplied increases to 20kg and so on.

The law of supply can be explained by the help of figure below:
Law of Supply
In the figure, OX axis represents quantity supplied and OY axis represents price of the commodity. SS is supply curve, which has been derived by joining different price-quantity combinations of above table. The supply curve is upward sloping which means that more is supplied in higher prices. The quantity supplied increases from 1kg to 10kg, 20kg, 30kg, when price increases from $2, $4, $6 and $8 respectively.

Exception to the Law of Supply

Some of the exceptions to the law of supply are as follows:
  1. Auction sale: The law of supply does not hold goods in auction sale. Auction sale may be made when a seller is badly in need of money. Hence, he will be prepared to sell all his goods at whatever the price offered. But even in auction sale, goods are sold to the highest bidder, which may be called the operation of law of supply.
  2. Clearance sale: The shopkeepers offer the clearance sale at heavily discounted price so as to get rid of the old stock. Hence, the law of supply does not hold good, since the shopkeepers attempt to sale more at lower price.
  3. Expectation of sellers: If the sellers expect that there will further fall in price in future, they will try to sell more even if price falls. Likewise, if they expect the further rise in price, they will not sell more even if the price is high. The sellers attempting to hoard food grain before the cultivating season and sell before harvesting season proves this.
  4. Fear of being out of fashion: The taste and fashion change from time to time. The advance of technology has brought rapid change in taste and fashion. This makes some of the goods out of fashion. Hence, if the change in fashion is expected, the sellers try to sell more at lower prices.

Derivation of Market Supply Curve and Shift in the Supply Curve

Derivation of Market Supply Curve

The sum of quantity supplied by all firms in the market at given price is called market supply. When this process is repeated at all prices, we find the total supply of all firms. The derivation of total supply is shown in the table below.

Individual and Market Supply Schedule
Price ($ per kg)
Supply of A (kg per month)
Supply of B (kg per month)
Supply of C (kg per month)
Market Supply (kg per month)
2
4
6
8
10
12
1
10
20
30
35
37
1
20
30
35
40
42
3
15
25
35
40
41
5
45
75
100
115
120

The supply schedule shows the quantity supplied by the producers at different prices. When price per kg is $2, the market supply is 5kg, when price is $4, the market supply is 45kg, when price is $6, market supply is 75kg and so on. This implies that the quantity supplied increase with increase in price.

The market supply curve SS is derived on the basis of the above supply schedule. The market supply curve SS is derived by joining each price-quantity points.
Market Supply Curve
The market supply curve SS also shows that quantity supplied is 5kg at $2, 45kg at $4, 75kg at $6 and so on.

According to R. G. Lipsey, “The supply curve of a commodity shows the price of the commodity and the quantity that the supplier is willing to supply at each time period.” This curve is drawn on the assumption that all the factors affecting supply are assumed to be constant. The market supply curve is also upward sloping or slopes upwards to the right. It implies that the producers are willing to supply more at high prices.

Shift in the Supply Curve

The shift in the supply curve means that at each price more is supplied than before. The increase in supply at each price has been shown in table below. Likewise, the shift in supply curve has been shown in table and figure below:

Two Alternative Supply Schedule
Price ($ per kg)
Original quantity supplied (units per month)
New quantity supplied (units per month)
2
4
6
8
10
12
5
45
75
100
115
120
28
76
102
120
132
140

It is seen in the table that more is supplied than before at the same price. As for instance, when price of sugar is $2 per kg, supply is 28kg, at $4, supply is 76kg, at $6, and supply is 102kg and so on.

When supply increases at each price, the supply curve shifts to the right from S1 to S2 as shown in figure. The supply may increase due to improvement in technology, fall in the price of other commodities, fall in the prices of factors of production, and change in the objective of producers.

Likewise, when the supply decreases at each price, the supply curve shifts to the left from S1 to S2 as shown in figure. The supply may decrease due to the end of technical knowledge, rise in the price of other goods, increase in the prices of factors of production, change in the objective of producers. As in demand curve, the change in the price of the commodity alone leads to movement along the same supply curve. This supply curve shifts due to the change in factors other than price of the commodity.

Factors Causing the Shift in Supply Curve

The quantity supplied depends on different factors. The change in price of a commodity alone leads to the movement along the same supply curve. But the change in the factors other than price leads to the shift in the supply curve. The factors causing shift in the supply curve can be explained as follows:
1. Price of factors of production: The production cost depends on the prices of factors of production. When the price of a factor of production increases, the cost of production of the commodities using more of that factor increases more. On the other hand, the cost of production of the commodities using less of that factor increases less. As for example, when the price of land increases, the cost of producing wheat increases more. But it has less effect on the cost of producing motorcar.

When the price of a factor changes, the relative profitability of different types of products also changes. Due to this the producers stop one type of production and start another type of production. On account of this, the quantity supplied of different commodities also change. In brief, the supply of a commodity decreases with increase in the process of production. A reduction in input prices induces firms to supply more output at each price, shifting the supply curve to the right. On the contrary, higher input prices makes production less attractive and shift the supply curve to the left.

2. Price of other commodities: The supply of a commodity is also affected by the prices of other commodities. If the price of a commodity increases and that of other commodities do not increase, in general, the production of that commodity relative to other commodities becomes less attractive. Hence, other things remaining the same, the supply of a commodity decreases when the price of other commodities rise. On the contrary, the supply of a commodity increases when the price of other commodities fall.

3. Goals of firms: Every firm has definite objectives. The objectives of a firm also affect the supply of a commodity. In general, if the objective of the firm is profit maximization, less quantity is supplied at higher price. On the contrary, if the objective is sales maximization, the firm supplies more at lower price. In traditional economics, it is generally assumed that the firms aim to maximize profit. At present some economists are of opinion that the firms have other objectives such as sales maximization objective has not declined.

4. State of technology: The state of technology is also an important determinant of supply. The improved technique of production has significantly increased the production in recent days. The improvement in the technique of production has been facilitated by the progress of science. The development of technology has affected the production and brought change in the supply of commodities. Hence, whenever there are changes in state of technology, the existing commodities are supplied more. Besides, the new commodities are also supplied. This will shift the supply curve to the right. In the long run, the change in technology causes change in cost and affects the supply of a commodity.

5. Effects of taxation: The taxation raises the prices of commodities. The imposition of tax on commodities leads to an increase in cost of production. This will generally result in a decrease in supply. A reduction of taxation will have the opposite effect.

6. Government Regulation: The government regulation also affects the quantity supplied of a commodity at each price. The most stringent safety regulations may prevent producers using the most productive process. Because, it is quite dangerous to workers. The anti-pollution devise raise the cost of production. The environmental regulation may make it unprofitable for firms to extract surface mineral deposits. “Whenever government regulations prevent producers from selecting the production method, they would otherwise have chosen, the effect of these regulations is to shift the supply curve to the left.” It has the effect of reducing quantity supplied at each price.

In addition to these factors, bad weather, strike, cost of transport and communication, time needed for the product also effect the supply of a commodity. In the short run, the price expectation of sellers may also affect the supply of a commodity.

Theory of Supply and Derivation of Single Producer's Supply Curve

Meaning of Supply

Supply like demand is also the function of price. It is expressed as, s = f(p). When the price of a commodity changes, the supply of the commodity changes. But unlike demand, supply varies directly with price. The supply has positive relationship with price. It implies that supply increases with increase in price and supply decreases with decrease in price. The supply is the quantity that a seller is willing to sell at particular price and particular time. According to Watson and Getz, “In economics, the word supply always means a schedule – a schedule of possible prices and of amounts that would be sold at each price.”
According to R. G. Lipsey, “The amount of commodity that firm are willing to offer for sale is called the quantity supplied of the commodity.”
The concept of supply curve is relevant only in perfect competitive market. The nation of supply curve is not applicable in other forms of market like monopoly, monopolistic competition. Because, the main task of a supply curve is to show how much a firm can supply at given price. In perfect competition, a firm is only a price-taker and quantity adjuster. It cannot influence price. In the imperfectly competitive markets, a firm determines the price of its product. It is not necessary to adjust supply at given price.

Derivation of Single Producer’s Supply Curve

The quantity supplied by a firm, other things remaining equal, changes directly with change in price of commodity. The supply increases with increase in price and the supply decreases with decrease in price. This tendency is expressed as s = f(p). It shows that the supply of a commodity depends on its price. This tendency is called the Law of Supply. When price of commodity is high, more profit can be earned. This induces firms to produce and sell more quantity. The supply of a firm is called individual supply.

The individual supply schedule is a schedule of prices of commodity and the supply of the commodity made by an individual firm. Similarly, an individual supply curve is a schedule of different quantity of goods supplied by an individual firm at different prices. The supply schedule, therefore, shows the relationship between the prices of a commodity and the quantity supplied. The individual producer’s supply schedule has been presented in table below.

Individual Supply Schedule
Price ($ per kg)
Quantity Supplied (kg. per month)
2
4
6
8
10
12
1
10
20
30
35
37
As shown in the table, the quantity supplied at price $2 per kg is 1kg, at $4 is 10kg, at $6 is 20kg, at $8 is 30kg and so on. It shows that quantity supplied increases with increase in price.

A market supply curve is derived by the horizontal summation of the supply curves of all individual sellers in the market. The individual firm’s supply curve SS has been derived in the following figure on the basis of above table.
Individual Supply Curve
In the figure, OX axis represents quantity supplied and OY axis represents price of sugar. SS is the supply curve. It shows that the quantity supplied increases with increase in price. The quantity supplied is 1kg at price $2, 10kg at $4, 20kg at $6, 30kg at $8, 35kg at $10 and so on. In this way, the supply curve shows the relationship between price of the commodity and the quantity supplied.

In general, the supply curve has positive slope or it slopes upwards to the right. This implies that a firm supplies more at higher price. Because, at low price only the efficient producers can produce hand make profit. But at high price, even the firms previously unable to compete begin to supply and earn profit. Moreover, previously existing firms may be able to expand output at high price. In general, higher prices are needed to provide an incentive for firms to produce more.

Law of Demand

Law of Demand

The law of demand is one of Alfred Marshall’s many contributions to economic theory. The demand varies inversely with price. The lower the price, the larger the quantity demanded. Similarly, the higher the price, the smaller the quantity demanded. This inverse relationship between price and quantity demanded is often called the Law of Demand. This law may be stated as – “Other things being equal, the higher the price of a commodity, the smaller is the quantity demanded and lower the price, the larger the quantity demanded.”

This law is based on The Law of Diminishing Marginal Utility. According to this law, when a man consumes more and more of a commodity, the utility from latter units declines. Hence, at a given time in given market, people will not buy more of a commodity unless its price becomes lower. The lower price induces the persons already buying to buy more and other persons to start buying.

The law of demand is based on several assumptions:

  1. Taste and preference of the consumer remain constant.
  2. Prices of substitutes and complements remain constant.
  3. Consumer’s income is fixed and constant.
  4. The size of the population is unchanged.
  5. There is no change in distribution of income and wealth.
Demand Schedule
Price ($)
Quantity
12
10
8
6
4
2
2
3
5
7
10
14

A demand schedule shows the relationship between two variables, price and quantity. To be more precise, it indicates the quantity demanded by the consumer at each price. As shown in the demand schedule, when price per unit is $12, the quantity demanded is 2 units, when price falls to $10, $8, $6 and $4 per unit, the quantity demanded increases to 3, 5, 7 and 10 units respectively.

This law can also be illustrated with the help of a diagram known as demand curve. When the demand schedule is displayed geometrically, it is called demand curve. The demand curve also shows the price-quantity relation as the demand schedule.
Law of Demand
In figure, OX axis represents quantity demanded and OY axis represent price. DD is the demand curve. The demand curve has been constructed on the basis of the demand schedule. It shows that when price is $12 per unit, the quantity demanded is 2 units. When the price falls to $10, the quantity demanded increases to 3 units. When the price further falls to $8, the quantity demanded increases to 5 units and so on.

The slope of a demand curve is negative. It always slopes downwards from left to right. It implies that when the price of a commodity falls, the quantity demanded of that commodity increases.

Causes of the demand curve sloping downwards

The demand curve slopes downwards to the right due to the following reasons:
  1. Law of Diminishing Marginal utility: According to this law as a consumer consumes more and more of a commodity, the marginal utility of the commodity goes on declining. Hence, people demand more only when the price falls.
  2. Income effect: When the price of a commodity falls, there is an increase in the real income or purchasing power of people. Hence, they are able to buy more of that commodity.
  3. Substitution effect: When the price of a commodity falls, it becomes cheaper than other commodities. So people buy more of this goods or substitute this goods for other.
  4. New consumers: When the price of a good fall, new consumers who did not buy before due to inability to buy also buy. So, the demand for the commodity increases. As for example, the transistors made in Khasa of China has decreased considerably. As a result of this, many people have started to buy transistors.
  5. Put to less important uses: When a commodity becomes cheaper, people are inclined to put them to less important uses. Hence, the demand increases when the price of a commodity falls.

Exceptions to the Law of Demand

There are several limitations to the law of demand, which are as follows:
  1. Judged by price: This exception is associated with the name of T. Veblen and his doctrine of conspicuous consumption. If consumers measure the commodity entirely by its price, they will buy less of the commodity when the price falls, and more when the price rises. As for example, the demand for diamond for personal use or premium priced beer. The demand for diamond by rich falls when price decrease.
  2. Giffen Goods: The other exception is associated with the name of Robert Giffen. According to him, a rise in the price of bread causes to buy more bread, not less. Because, the wage earners subsist on the diet mainly of bread. When its price rises, they have to spend more money for a given quantity of bread. So, to maintain their intake of food, they buy more bread at higher price. According to Watson and Getz, these two exceptions to the law of demand are quite important.
  3. Price exception: To quote Watson and Getz again, the other exceptions to the law of demand are only apparent not real. When the consumers expect the price to fall even further, they do not buy more even if the price is lower. Likewise, when the consumer expect further rise in price, they buy more even if the price is higher.
  4. Articles sold under two brand name: The article may be sold under two brand names at the same time. The consumers buy more of the higher-priced brand than the lower-priced brand even though the articles are more or less identical. But the consumers think that the two brands are different. The two brands are taken as two different commodities.
  5. If shortage is feared: If people feel that the commodity is going to be scarce in future, they buy more of it even if the price is high. As for example, when people feel that cooking gas or kerosene is going to be of short supply in future, they buy more even if price is high.
  6. Out of fashion: If the commodity goes out of fashion, people do not buy more even if the price falls, as for example, people do not buy bell-bottom pants or pointed shoes these days even if their prices are lower relatively. Because, their use has gone out of fashion.
  7. Customs and tradition: The law of demand may not hold goods due to customs and traditions. As for example, the demand for clothes, goat increase during Dashain festival even if the prices are too much higher.
  8. Change in season: The law of demand may not hold good due to the change in season. The demand for umbrella does not rise even if price falls during winter season. Likewise, the demand for ice cream, Coca-Cola does not rise during winter even if price is substantially reduced.
  9. Necessaries of life: The necessaries of life are the things that the people cannot do without. Hence, even if the price of rice increases, the demand does not decrease.
  10. Change in income: If the income of people increase, they do not reduce demand for the commodities even if the price rise. On the contrary, if their income decreases, they reduce the demand even if the price of commodities falls.

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