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Law of Supply

Law of Supply

Author: Kate Eskra

Identify key aspects of the supply curve with regards to the Law of Supply.

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Source: Image of Supply Graph created by Kate Eskra

Video Transcription

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Hi. Welcome to Macroeconomics. This is Kate. This tutorial is on the Law of Supply. As always, my key terms are in red, and my examples are in green. So in this tutorial I'll explain the law of supply to you. You'll be able to interpret a supply schedule, and you'll see a supply graph. We'll talk about why supply curves are upward sloping. And we'll also discuss why ceteris paribus is important when discussing supply.

So usually in economics we learn about demand before supply, simply because it's easier to think like a consumer. Demand is all about buying things, and looking for low prices, and not purchasing as much when prices go up. To really understand the relationship between price and quantity for supply, you have to think like a supplier or a producer of something. And many of us are not business owners. So that doesn't mean that supply isn't relevant to you in your life.

I usually pose the question to my students about people offering them certain wages. Because when you are supplying your labor, this is a supply issue. So think about it this way. If your boss offers you minimum wage to work overtime this weekend, would you supply many hours? And often my students answer, no, it's not worth my time. Well, what if he offers you $100 per hour, would you be willing to supply more hours then? And most of them clearly answer, oh yes, then it's definitely worth it. That's the idea of supply. So just think about supplying your labor if it gets confusing to you.

Supply is all about being able to produce something, and willing to supply it at a price. So I'm going to use my apples example. If watched my demand tutorials, I stuck with this theme. So here's a farmer's willingness to supply apples. And this is a supply schedule. Because what it does is it has all the different prices of apples, and the quantities, not that he's willing to buy with demand, but the amount that he's willing to supply at those various prices. So had we interviewed farmers and said, how many you would you supply at these prices. This would be their responses.

And this would be in thousands or millions, or something. I'm just simplifying it by giving you some nice round numbers. If we plot those points, you can see that as the price goes up, his willingness to supply increases. As the price falls, the farmer is supplying less. So this is a very different relationship between price and quantity, as it was with demand. Here's price on the y-axis. Here's the quantity on the x-axis.

With demand, there is an inverse, or a negative relationship between price and quantity. Here notice that the two are moving in the same direction. So this is what we would call a positive relationship between price and quantity.

So the law of supply says that if the price of a good decreases, the quantity supplied decreases. It would work the other way as well, obviously. If the price of a good increases, the quantity supplied increases. The idea here again is that there is a positive or direct relationship between price and quantity when it's coming to supply.

So why is a supply curve upward sloping? So why is there a positive relationship between price and quantity? Let's think about it this way. With a really low market price for apples, only farmers in certain areas in our country would be able to profit from growing apples. Let's say in areas where there's really ideal apple growing conditions. So they wouldn't have to pay for a lot of technology to make their land suitable for growing apples. Maybe only in areas where there are relatively low labor costs, so nowhere near cities where the labor costs are much higher.

However, as the market price of apples would go up, it would then become possible for more people to get into the business and begin to make a profit. Maybe people who do have to pay a little bit of money to make their land more suitable, or do have to pay a little bit more money for labor. So you can see that as the market price goes up, more people are going to be able to profit.

Also people in other lines of business might be enticed now into this apple-growing line of business. They might find it profitable to change over actually. It really depends on the opportunity cost. So it depends on what they're giving up. Remember opportunity cost is defined as the sacrifice we make when we choose one value or opportunity over another. It's the value of the foregone opportunity. And supply really-- someone's ability or willingness to supply something definitely deals with the opportunity cost of deciding to produce it.

So now we need to talk about the law of supply and this phrase, ceteris paribus. As the price of apples falls, like I said, we can expect that farmers will produce fewer apples. Ceteris paribus means holding everything else constant. So what that assumes is that only the price of apples has changed. Nothing else has changed. So they're supplying fewer apples not because of anything else. So the price of their resources or inputs didn't change, their technology did not change. Only the price of apples has changed.

And so when we have a change in price you can see here that this is just moving along the curve. As price goes up, they're supplying a greater quantity. We just plot a point higher up here on the supply curve. As price falls, we go to a point lower and lower on the supply curve. Because it's only involving a relationship between the two axes here, between price and quantity, we don't need to draw a whole new curve. We just find which point is represented by that price and quantity combination.

So how we would talk about it is this is a change in quantity supplied, not a change in supply itself. So for example, we would not say, oh, the price of apples went up, so the supply would increase. We would say, the price of apples went up, so farmers are willing to supply a greater quantity, or the quantity supplied increased.

So this is a known as movement along a supply curve. And this is movement caused by a change in price. Assuming everything else is constant, that idea of ceteris paribus. We'll be talking about, in another tutorial, all of the things that change other than price that will affect production decisions for a particular good. When anything other than the price of the good that impacts a farmer or a producer or something, anything like that changes other than price will have the ability to shift supply. But that's not what we're talking about here. A change in price just causes movement along the supply curve.

So in this tutorial we talked about how the law of supply describes the relationship between price and quantity. And it is a positive relationship between them. And that's why we have an upward sloping supply curve. When we're dealing with moving along that supply curve, we hold everything else constant, which is the idea of ceteris paribus. And again to reiterate, a change in the price of a good or service will cause movement along a supply curve, and is known as a change in quantity supplied. Thanks so much for listening. Have a great day.

Terms to Know
Law of Supply

If the price of a good decreases, the quantity supplied decreases.

Movement Along Supply Curve

Movement caused by a change in price, assuming all other variables are held constant.

Opportunity Cost

The sacrifice made by choosing one value or opportunity over another; the value of the forgone opportunity.

Shift in Supply

Changes other than the price of the good itself that affect production decisions for a particular good.