Law of supply refers to that state where other things remaining the same as the price of the product is increased the supply of the product will increase and when the price of product decrease it leads to decrease in the supply of product. Law of supply has many assumptions let’s look at some of the assumptions of law of supply –
- The first and foremost assumption of law of supply is that there is no change in the cost of production for the firm because if the cost of production increases than it will lead to company making same number of units even when the price of product has increased because as far as company is concerned for them their profit margin will be same due to rise in cost of production. Conversely, if the cost of production decreases then the company can increase production even price of the product has not increased because the profit margin as far as the company is concerned is same.
- The state of technology should be static because if technology improves than company due to improvement in technology can produce at a lower cost per unit which in turn can lead to increase in production without an increase in the price of the product.
- Another assumption of law of supply is that the number of firms present in the market should remain the same because if the number of firms selling same product increases than it will result in increase in production of the product without any corresponding rise in price and conversely if the number of firms declines then it will result in decrease in the supply without any decrease in price of the product.
- Another assumption is that the seller’s expectations regarding the future price of product should not change because if seller expects further rise in price of the product in future than he or she will not increase supply the product even when price is increased and conversely if seller expects further decline in price than he or she will not decrease the supply even when price of products are reduced.
- Another assumption is that there is no change in taxation policy of the government because if the government increases the tax on production then it will increase the cost of production which will lead to fall in production even when there is no increase or decrease in price and conversely if government reduces taxes or increases subsidies than it will lead to fall in the production cost leading to rise in the production without any rise in the price of product.
As one can see from the above that law of supply is based on many assumptions and it is together with the law of demand is a key concept of economics when it comes to determination of the price of the product in the market.