What is the Law of Supply?

The law of supply is a basic economic principle stating that as supply for a certain product increases, the price for that product will also increase. This is typically seen with new products that are in high demand, but may also apply to many other products, including commodities. The laws of demand and supply are often compared and used with one another, but are independent economic theories.

While the law of supply suggests that companies tend to maximize profits by producing products as their price increases, that is not always the case. Certainly, if a company sees a price increase and can produce a product for the same cost, it will take advantage of that situation as long as it can. In some cases, however, producing more of a product leads to certain inefficiencies. For example, a company may have to pay overtime or call for unscheduled deliveries, both of which make production more expensive. This could increase the price, yet only maintain the profit margin at previous levels.

In economics, the law of supply is often noted with what is known as a supply curve, though typically the model is a straight line extending upward from left to right. On the x-axis, or horizontal line, is the quantity. On the y-axis, or vertical line, is the line for price. Typically, the model is shown just for general reference, with no product, price, or supply quantity being mentioned on the graph.

There is a close association between the laws of demand and supply because the two work hand in hand. As the supply increases with the price, demand will eventually drop. Eventually, that will lead to a drop in price as companies try to get rid of excess inventory. Often, the two lines are shown on the same graph and jointly referred to as the law of supply and demand, even though they are two separate laws. Generally, supply and demand are two opposing forces that work against each other until supply and demand come into equilibrium.

Given the law of supply indirectly suggests that maximizing profits encourages a company to produce more, many see this law as a way to stimulate economies during periods of recession. These individuals subscribe to what is known as the supply-side theory. They often cite this theory as a reason for lowering income and other taxes on corporations in an effort to stimulate the private sector and encourage economic growth.