Theory of Supply: Supply Function and Law of Supply

Supply Function

Supply Function:

It can be expressed as S(x) = f (Px).

Supply function explains as to how the quantity supplied of a commodity changes on account of changes in determinants of supply.

This function expresses the relationship between supply and price. It also gives us an idea that quantity of a commodity supplied varies directly with its price, other determinants of supply remaining constant.

Supply and price has a positive relationship. Therefore, they move in the same direction.

Supply function:

Q(x) = f [Px, P1, P2, Pn………. f1, f2, fn……. T, O]

Here,

Q(x) – quantity supplied of the commodity x

P(x) – price of the commodity x

P1, P2, Pn – price of other commodities

f1, f2, fn – cost of production

T – technology

O – objective of supplier/firm

Law of Supply

Law of Supply states that other things remaining constant, the quantity supplied varies directly with the price of the commodity. It also explains that when price of a commodity increases, the supply expands and vice-versa. The relationship between supply and price is positive. Therefore, higher the price, larger is the supply; lower the price, lesser is the quantity supplied.

Assumptions of Law of Supply:

Various assumptions of Law of Supply are as follows: -

1. Number of firms in the market remain constant.
2. There is no change in the level of technology.
3. Cost of production does not change.
4. Rate at which production takes place remains constant.
5. Prices of related goods remain constant.
6. Climatic conditions do not change.
7. The seller does not expect any drastic change in the price of the commodity in near future.
8. Preferences of the consumer remain same.
9. There is no change in government policies.

Importance of Law of Supply:

1. Price Determination: The law of supply, along with the law of demand, is a key factor in determining market prices. It helps explain how the interaction between buyers and sellers in a market leads to price equilibrium.

2. Production and Supply Decisions: Businesses use the law of supply to guide their production decisions. When prices are high, businesses are motivated to produce and supply more to maximize profits. Conversely, when prices are low, they may reduce production to avoid losses.

3. Market Efficiency: The law of supply helps ensure that markets are relatively efficient in allocating resources. It helps to avoid surpluses (too much supply) and shortages (too little supply) by guiding producers to adjust their output based on price signals.

4. Forecasting and Planning: Businesses and policymakers can use the law of supply to forecast how changes in price or other factors (like technology or government policies) might affect production and supply.

5. Understanding Market Dynamics: The law of supply provides insights into how producers respond to changes in market conditions.

Exceptions / Limitations of law of Supply:

There are some situations under which the law of supply of goods is not applicable. It means that the supply of goods and the price of a commodity are not proportional. The exception of the law of supply is as mentioned below:

1. Monopoly - The situation when there is only one vendor of a service refers to monopoly. The single seller is the price maker and has control over different prices. The seller may not be willing to raise the supply even if the prices are going high, hence it is an exception to the law of supply.

2. Closure of Business - In some circumstances when a business is on the edge of closure, the seller may sell the products even at cheap prices. The retailer does this to clear the supply of stock. In this case, the law of supply does not hold and serves as an exception to the law of supply example.

3. Perishable Goods - Sometimes sellers are keen to sell perishable or fresh goods even at cheap prices. It is because, for the perishable goods, sellers cannot wait for a long time and if these types of goods remain unsold, then they will face only loss. 

4. Competition - When there is high competition in the market, the sellers may sell goods in high quantities at low rates. It refers to a situation where the law of supply does not hold. 

5. Agricultural Products - It is challenging to increase the agricultural produce at a certain level as land is a limited resource. It shows that if the prices of land increase, the supply may not get increased.

6. Out of Fashion Goods - The up-to-date goods that are in trend often have high prices. However, those goods, which are out of fashion, have cheap prices. The sellers may sell these out of fashion goods even at cheap rates. 

7. Rare Goods - The goods that are precious or artistic generally have a limited supply. The supply of these goods cannot be raised according to the rising prices or demand. Hence, if the price of the goods increases, the supply of such rare goods cannot be raised. It is also an exception to the law of supply example.

Supply Schedule:

A supply schedule has two main types:

1. Individual Supply Schedule
2. Market Supply Schedule

Individual Supply Schedule: This shows the quantity of a good that a single producer or firm is willing to offer at different prices during a specific time period, assuming all other factors remain constant.

Market Supply Schedule: This represents the total quantity of a good that all producers in a market are willing to supply at various prices during a given period, essentially the sum of all individual supply schedules.

Sample Supply Schedule:

Supply Curve:

If we show the supply schedule graphically, we get the supply curve. The Supply Curve shows the maximum quantities per unit of time that producers will supply at various prices.

The Supply Curve slopes upward from left to right.

Reasons for upward sloping of Supply Curve:

The supply curve slopes upward from left to right primarily due to the relationship between price and quantity supplied. There is a positive relationship between the price and quantity supplied. Here are the main reasons:

1. Profit Motive - When the price of a product increases, producers can earn more profit per unit sold. This encourages them to increase production to take advantage of the higher profitability. 

2. Increasing Marginal Costs - As a company expands its production, it may need to use more resources (labour, materials, etc.), which can lead to higher costs for each additional unit produced. To justify the increased production costs, producers need to sell their goods at a higher price. 

3. Diminishing Marginal Returns - As a business increases inputs (like labor or capital), it may experience diminishing marginal returns, meaning each additional unit of input adds less and less to total output. To offset the diminishing returns and maintain profitability, firms need to charge higher prices as they produce more.

4. Market Dynamics - When demand for a product increases, it drives up the market price. This higher price incentivizes producers to increase their supply to meet the growing demand and capitalize on the higher prices. Changes in price cause movements along the supply curve. For example, if the price of a good increases, the quantity supplied will increase, moving along the existing supply curve.

Factors affecting Supply / Cause of change in supply:

1. Production Costs - Changes in the cost of raw materials, labour, or other inputs directly affect production costs. For example, if the price of coffee beans increases, the cost of producing coffee will also increase, potentially leading to a decrease in supply. Advancements in technology can lower production costs by making processes more efficient or enabling the use of new materials. This can lead to an increase in supply. 

2. Number of Sellers – If more firms enter a market, the overall supply will increase. Conversely, if firms exit the market, the supply will decrease. Increased competition among sellers can also influence the overall supply.

3. Government policies -  Taxes on production can increase costs and decrease supply, while subsidies can lower costs and increase supply. 

4. Speculations - If sellers expect future prices to be higher, they may decrease current supply to sell more later. Conversely, if they expect prices to fall, they may increase current supply to avoid losses.

5. Price of Related Goods - If the price of a substitute good increases, sellers may shift production towards that good, potentially decreasing the supply of the original product. If the price of a complementary good increases, the supply of the original product may also increase as it becomes more profitable to produce both together.

Change in Supply:

Change in the supply refers to the movement along the same supply curve due to change in price of the commodity. However, when the change in supply is associated with change in factors like cost of production, technology, innovation etc., it causes a shift of supply curve upwards & downwards.

When the prices of inputs like labour and raw materials used for the production of a commodity declines, it results in lowering the cost of production, which will induce the producer to produce more and make available a greater quantity of the commodity in the market. This reduction in price of inputs leads to increase in supply of commodity, which cause the entire supply curve to shift towards the right (upward movement).

Different kind of changes in supply:

1. Increase in Supply
2. Decrease in Supply
3. Extension of Supply
4. Contraction of Supply

Difference between Increase in Supply and Decrease in Supply:

Difference between Extension of Supply and Contraction of Supply:

Difference between Increase in Supply and Extension of Supply:

Difference between Decrease in Supply and Contraction of Supply:

Note: - in all the differentiations above, do make diagram of each (increase, decrease, extension, contraction) in each distinction, depicting their movement.