The Law of Supply

The Law of Supply states that, other things remaining constant (ceteris paribus), the quantity supplied of a commodity is directly (positively) related to its price — as price rises, quantity supplied rises, and as price falls, quantity supplied falls.

Assumptions. The law holds only when the cost of production, the state of technology, government tax/subsidy policy, the prices of related goods, and sellers' price expectations all remain unchanged, and the commodity is not one of the recognised exceptions (see below).

Why does supply rise as price rises? The reasoning centres on the seller's profit motive and the behaviour of production cost:

1. Profit motive. A higher price, cost remaining the same, means a higher profit margin per unit — sellers are induced to produce and offer more.
2. Rising marginal cost. As a firm produces additional units in the short run, the marginal cost of production typically rises (due to the law of diminishing returns to the variable factor). A seller will supply an additional unit only if the price at least covers its (higher) marginal cost — so a higher price is needed to call forth a larger quantity supplied. …