Determinants and Law of Supply

19/12/2020 1 By indiafreenotes

Demand and Supply are two pillars of business economics. Demand is the quantity of a good or service that consumers are willing and able to purchase at different prices during a period of time.

Supply refers to the amount of a good or service that the producers/providers are willing and able to offer to the market at various prices during a period of time. There are two important aspects of supply:

  • Supply refers to what is offered for sale and not what is finally sold.
  • Supply is a flow. Hence, it is a certain quantity per day or week or month, etc.

Determinants of Supply

Price of Related Goods

Let’s say that the price of wheat rises. Hence, it becomes more profitable for firms to supply wheat as compared to corn or soya bean. Hence, the supply of wheat will rise, whereas the supply of corn and soya bean will experience a fall.

Hence, we can say that if the price of related goods rises, then the firm increases the supply of the goods having a higher price. This leads to a drop in the supply.

Price of the Good/ Service

The most obvious one of the determinants of supply is the price of the product/service. With all other parameters being equal, the supply of a product increases if its relative price is higher. The reason is simple. A firm provides goods or services to earn profits and if the prices rise, the profit rises too.

Price of the Factors of Production

Production of a good involves many costs. If there is a rise in the price of a particular factor of production, then the cost of making goods that use a great deal of that factors experiences a huge increase. The cost of production of goods that use relatively smaller amounts of the said factor increases marginally.

For example, a rise in the cost of land will have a large effect on the cost of producing wheat and a small effect on the cost of producing automobiles.

Therefore, the change in the price of one factor of production causes changes in the relative profitability of different lines of production. This causes producers to shift from one line to another, leading to a change in the supply of goods.

Government Policy

Commodity taxes like excise duty, import duties, GST, etc. have a huge impact on the cost of production. These taxes can raise overall costs. Hence, the supply of goods that are impacted by these taxes increases only when the price increases. On the other hand, subsidies reduce the cost of production and usually lead to an increase in supply.

State of Technology

Technological innovations and inventions tend to make it possible to produce better quality and/or quantity of goods using the same resources. Therefore, the state of technology can increase or decrease the supply of certain goods.

Other Factors

There are many other factors affecting the supply of goods or services like the government’s industrial and foreign policies, the goals of the firm, infrastructural facilities, market structure, natural factors etc.