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Law of Supply
Law of Supply
The law of supply states that there is a direct relationship between price and quantity supplied. In other
words, when the price increases the quantity supplied also increases. This is represented by an upward
sloping line from left to right.
Why is the law of supply true? Why is the supply curve upward sloping? Why will businesses supply
more pizzas only id the price is higher? I think it is just common sense. If you want the pizza places to
work harder and longer and produce more pizzas, you have to pay them more, per pizza. But
economists, as social science, want to explain common sense. We know businesses behave this way, but
There are two explanations for the law of supply and both have to do with increasing costs. Businesses
require a higher price per pizza to produce more pizzas because they have higher costs per pizza. Why?
First, there are increasing costs because of the law of increasing costs. In a previous lecture we
explained that the production possibilities curve is concave to the origin because of the law of increasing
costs. the law of increasing costs is true because not all resources are identical. Let's say a pizza place is
just opening. The owner figures that they will need five employees. After putting an ad in the paper
there are twenty applicants. Five have had experience working in a pizza place before. They came to the
interview clean and on time. The other fifteen had no work experience. Many came late. A few were
caught steeling pepperoni on the way out. One spilled flour all over the floor. Which applicants will be
hired? Of course it will be the five with experience and the other fifteen will be rejected because they
would be too costly to hire. NOW, if the pizza place wants to produce more pizzas they will need more
workers. This means they will have to hire some of those who were rejected because they were more
costly (less experienced, etc.). So, they will only hire the more costly employees if they can get a higher
price to cover the higher costs. this is one explanation why the supply curve is upward sloping.
Second, there are increasing costs because some resources are fixed. This should not make sense to you.
Why would there be increasing costs if we use the same quantity of some resource? Well, let's say that
the size of the kitchen and the number of ovens (capital resources) are fixed. This means that they don't
change. Now, if we want to produce more pizzas you will have to cram more workers into the same size
kitchen. As they bump into each other and wait for an oven to be free they still get paid, but the cost per
pizza increases. Therefore they will not produce more pizza unless they can get a higher price to cover
these higher per unit costs. So the supply curve should be upward sloping.
DEFINITION of 'Law Of Supply'

A microeconomic law that states, 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.


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2. Law of Demand and Supply
DEFINITION of 'Law Of Supply And Demand'
A theory explaining the interaction between the supply of a resource and the demand for that
resource. The law of supply and demand defines the effect that the availability of a particular
product and the desire (or demand) for that product has on price. Generally, if there is a low
supply and a high demand, the price will be high. In contrast, the greater the supply and the
lower the demand, the lower the price will be.
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3. Non-price determinants of Demand, Supply

The following list enumerates the non-price determinants of demand. These factors are important,
because they can change the number of units sold of products and services, irrespective of their
prices. The determinants are:

Branding. Sellers can use advertising, product differentiation, product quality, customer service, and
so forth to create such strong brand images that buyers have a strong preference for their goods.

Market size. If the market is expanding rapidly, customers may be compelled to purchase based on
other factors than price, simply because the supply of goods is not keeping up with demand.

Demographics. A change in the proportions of the population in different age ranges can alter demand
in favor of those groups increasing in size (and vice versa). Thus, an aging population will increase the
demand for arthritis drugs, while a younger population will increase the demand for sporting goods.

Seasonality. The need for goods varies by time of year; thus, there is a strong demand for lawn
mowers in the Spring, but not in the Fall.

Available income. If the amount of available buyer income changes, it alters their propensity to
purchase. Thus, if there is an economic boom, someone is more likely to buy, irrespective of price.

Complementary goods. If there is a price change in a complementary item, it can impact the demand
for a product. Thus, a change in the price of popcorn in a movie theatre could impact the demand for
movies, as could the price of nearby parking.

Future expectations. If buyers believe that the market will change in the future, such as may happen
with an anticipated constriction of supplies, this may alter their purchasing behavior now. Thus, an
expected constriction in the supply of rubber might increase the demand for tires now.
These determinants will alter the demand for goods and services, but only within certain acceptable
price ranges. For example, if non-price determinants are driving increased demand, but prices are
very high, it is likely that buyers will be driven to look at substitute products.
The most important non price determinants of supply include:
costs of production
government intervention in the form of taxes and subsidies
price of related goods
supply side shocks.
Each of these can be explained as follows:

Costs of Production

In the following news article (see this link) Peugot car manufacturer has had to cut back out put due
to the increasing cost of higher wages for car workers. In creasing factor costs such as wages will
increase the cost of producing each unit at all price levels. The supply curve will shift to the left
indicating a decrease in supply at all price levels. The market will reach a new equilibrium price, with
output falling and price rising.
If the workers were to accept a cut in wages as a result of decreasing demand for cars and falling
profits of the manufacturer then the supply curve would shift to the right indicating cheaper costs of
production for each unit at all price levels and the firm would supply more at each price.The supply
curve above would shift from S1 to S. The new equilibrium price would fall from p1 to p and output
would increase from Q1 tp Q.

Productivity is the amount of out put per worker. Using the same quantity of resources(and therefore
costs of the factors of production) the output will be greater if there is increasing productivity at all
price levels. This can be seen in the following model

If a firm has introduced a more advanced production process this will allow the output to increase
using the same amount of resources(costs) At all price levels output will increase . In the model we
can see that at price P1( costs of production) output will have increased to q1. Similarly if a firms
costs of producing a product were p1, the implementation of a more efficient process would see
output increase to Q2 and so on.
If productivity were to fall for any reason then the supply curve would shift to the left, and output ,at
all price levels would fall.

Government Intervention
Governments will for a range of reasons place indirect taxes on the production of some goods and
services. This could be to raise revenue from the tax or to try to decrease supply of some goods
considered to be disadvantageous to the community(cigarettes)
An Indirect tax will shift the supply curve to the left(see fig below)

If the government was to place a tax on cigarettes the effect will be to raise the cost of production of
each unit put. If price was remain constant then firms would lose profit on each unit produced and so
reduce output. The effect will be to shift the supply curve to the left from S to S1. In a market this will
lead to an increase in the price of cigarettes and consumers would respond by decreasing the
quantity demanded (Law of Supply) and output would fall from Qo to Q1.

A subsidy is a payment by a government for a producer to produce more of a good. In Indonesia ,
rice is subsidised by the government to ensure the governments policy on National food supply
independence is met.
Rice can be produced more efficiently(using fewer resources and therefore costs ) in Myanmar and
Vietnam. To encourage food self sufficiency in Indonesia the government will pay producers an
amount for each unit produced. The effect of the subsidy is to lower the costs of production for the
iNdonesian farmer , so that he can compete with imports. The farmer will therefore increase his
output and thus the Supply curve will shift to the right. This can be seen in the following market

In the above model the rice producer will produce quantity Q* at price P*. If the government
subsidises the farmer by paying a sum per unit produced , this will reduce the farmers costs of
production per unit . The farmer will now increase output at any price level , and the supply curve will
shift to the right. The market equilibrium will now see price fall from P* to P1 and output increase
from Q* to Q1

Non-Price Determinants of Supply

Changes in Production Technology.

Changes in the Cost of Factor Inputs (Resources).

Changes in the Number of Sellers in the Market.

Changes in the Expectations of Future Prices.

Changes in the Prices of Related Substitute Goods, and


4. Price Floor, Price Ceiling

Price Floors and Price Ceilings are Price Controls, examples of government intervention in the
free market which changes the market equilibrium. They each have reasons for using them, but
there are large efficiency losses with both of them.
Price Floors
Price Floors are minimum prices set by the government for certain commodities and services
that it believes are being sold in an unfair market with too low of a price and thus their
producers deserve some assistance. Price floors are only an issue when they are set above the
equilibrium price, since they have no effect if they are set below market clearing price.
When they are set above the market price, then there is a possibility that there will be an excess
supply or a surplus. If this happens, producers who can't foresee trouble ahead will produce the
larger quantity where the new price intersects their supply curve. Unbeknownst to them,
consumers will not buy that many goods at the higher price and so those goods will go unsold.
There will be economic harm done even if suppliers can look ahead and see that there isn't
sufficient demand and cut back on production in response. There is still deadweight loss
associated with this reduction in quantity, reflected in the loss of consumer and producer
surplus at lower levels of production. Producers can gain as a result of this policy, but only if
their supply curve is relatively elastic and therefore they have no net loss. Consumers will
definitely lose with this kind of regulation, as some people are priced out of the market and
others have to pay a higher price than before.
There are numerous strategies of the government for setting a price floor and dealing with its
repercussions. They can set a simple price floor, use a price support, or set production quotas.
Price supports sets a minimum price just like as before, but here the government buys up any
excess supply. This is even more inefficient and costly for the government and society as a
whole than the government directly subsidizing the affected firms. Production quotas artificially
raise the price by restricting production using either mandated quotas or giving businesses
incentives to reduce their production. In America, this latter technique is used widely with
agriculture. The government pays farmers to keep some portion of their fields fallow, thus
elevating prices. Like price supports, the policy would be more efficient and less costly to society
if the government directly subsidized farmers instead of setting a production restriction.

Price Ceilings
Price Ceilings are maximum prices set by the government for particular goods and services that
they believe are being sold at too high of a price and thus consumers need some help
purchasing them. Price ceilings only become a problem when they are set below the market
equilibrium price.
When the ceiling is set below the market price, there will be excess demand or a supply
shortage. Producers won't produce as much at the lower price, while consumers will demand
more because the goods are cheaper. Demand will outstrip supply, so there will be a lot of
people who want to buy at this lower price but can't. Still, if the demand curve is relatively
elastic, then the net effect to consumer surplus will be positive. Producers are truly harmed, as
their surplus is doubly hit with a reduction in the number of firms willing to take that lower
price, and those who remain in the market have to take a lower price.
The resulting shortage of goods can lead to consumers having to queue up in line to get the
good, government rationing, and even the development of a black market dealing with the
scarce goods. This is what occurred with the energy crisis in America during the 1970s, when
cars had to line up on the street in order to just get some government rationed amount of
5. Shortage and Surplus
Sometimes the market is not in equilibrium-that is quantity supplied doesn't equal quantity
demanded. When this occurs there is either excess supply or excess demand.
A Market Surplus occurs when there is excess supply- that is quantity supplied is greater
than quantity demanded. In this situation, some producers won't be able to sell all their goods. This
will induce them to lower their price to make their product more appealing. In order to stay
competitive many firms will lower their prices thus lowering the market price for the product. In
response to the lower price, consumers will increase their quantity demanded, moving the market
toward an equilibrium price and quantity. In this situation, excess supply has exerted downward
pressure on the price of the product.
A Market Shortage occurs when there is excess demand- that is quantity demanded is
greater than quantity supplied. In this situation, consumers won't be able to buy as much of a good
as they would like. In response to the demand of the consumers, producers will raise both the price
of their product and the quantity they are willing to supply. The increase in price will be too much
for some consumers and they will no longer demand the product. Meanwhile the increased
quantity of available product will satisfy other consumers. Eventually equilibrium will be reached.