Law of supply

Miss Informed · 13-11-2015 4:08pm #1

Hey guys,

I'm confused about the law of supply;

"The law of supply is a fundamental principle of economic theory which states that, all else equal, an increase in price results in an increase in quantity supplied. In other words, there is a direct relationship between price and quantity: quantities respond in the same direction as price changes."

I've always associated higher quantities with lower prices and lower quantities with higher prices... Ie mass produced toys/watches = cheap, high quality watches, diamonds = expensive.

Also with a larger output decreasing the cost per unit, so why is the supply curve upwards sloping?

KomradeBishop · 14-11-2015 4:04pm

That's assuming that the increase in price is based on an increase in demand - so it's inherently violating 'all else equal' (as all else can not be equal, if demand needs to increase as well, for this to be true).

The supply/demand curve theory that you get taught in economics courses, is really flawed - there are a huge number of exceptions in the real world.
Here's an entire detailed post and comment section, arguing that in the real world, the supply curve tends to be flat - lots of good information there.

Recommend Steve Keen's 'Debunking Economics' book, so that you avoid being inculcated into accepting a lot of the nonsense that gets taught in the average economics course.

A handy tip: Whenever you see a theory stating 'ceteris paribus' i.e. 'all else equal' - you should get really suspicious that it may be nonsense, because it's rarely ever true that all else is equal - it's a sleight-of-hand that many economic theories use, to try and get you to accept an assumption as true, when it is usually false (there are exceptions though - it is sometimes used legitimately - just keep your guard up).

Many people teaching this stuff will plead that the theories are not meant to be 'perfect' (a weasel-word used to imply that the theory is still mostly true and applicable/useful in the real world, even though it is not) - but that's another thing you should get incredibly suspicious of, because a lot of things taught should just be binned really - you want to be learning about real world economics, not about imaginary-world economic 'models', which actually do a really poor job of modelling how real economies work.

A fair number of the basics and principles you learn on a standard economic course, are all the building blocks of a wide range of economic models, which unfortunately don't actually represent reality very well at all - some of them are useful for learning purposes, but many are just plain misleading.

andrew · 17-11-2015 6:40pm

Miss Informed wrote: »

Hey guys,

I'm confused about the law of supply;
"The law of supply is a fundamental principle of economic theory which states that, all else equal, an increase in price results in an increase in quantity supplied. In other words, there is a direct relationship between price and quantity: quantities respond in the same direction as price changes."
I've always associated higher quantities with lower prices and lower quantities with higher prices... Ie mass produced toys/watches = cheap, high quality watches, diamonds = expensive.

Also with a larger output decreasing the cost per unit, so why is the supply curve upwards sloping?

So when looking at the supply and demand model, or any other model, it’s important to consider each of the parts individually, and then consider how they interact. By noting your intuition that an increased price might mean that supply is greater than demand, and then the price would have to fall, you’re getting slightly ahead of yourself in terms of considering the dynamics of the model etc.

So, with the law of supply, you’re just looking at the supply curve only. And asking, if the price was to go up (imagine it’s because the government sets the price and can raise it and lower it at will), how would producers react? Well, since the price is higher, they’d produce more. At this point, we don’t have any interaction from any other outside force, and we’re just trying to show how price affects quantity supplied.

Introducing demand into the model and making ir more realistic makes things slightly trickier. In particular, when the price changes, you can’t know whether this is because of some change in demand, or some change in supply. For example, if the supply curve shifts to the right (and the demand curve stays where it is), then at equilibrium, the price is lower. Equally, if the demand curve were to shift to the left, and the supply curve to stay where it is, the equilibrium price would be lower. So, when looking at the model as a whole, we don’t make an inferences from a change in price; we don't say, the price changed therefore supply or demand changed.

Rather, the purpose of the law of supply is to formalise the fact that that at higher price suppliers will want to produce more. However, the actual price and quantity produced depends on where the intersection of the supply and demand curve is, and the equilibrium price is caused by movements in the supply and demand curves, and not the other way around.

KomradeBishop wrote: »

That's assuming that the increase in price is based on an increase in demand - so it's inherently violating 'all else equal' (as all else can not be equal, if demand needs to increase as well, for this to be true).

The supply/demand curve theory that you get taught in economics courses, is really flawed - there are a huge number of exceptions in the real world.
Here's an entire detailed post and comment section, arguing that in the real world, the supply curve tends to be flat - lots of good information there.

Recommend Steve Keen's 'Debunking Economics' book, so that you avoid being inculcated into accepting a lot of the nonsense that gets taught in the average economics course.

A handy tip: Whenever you see a theory stating 'ceteris paribus' i.e. 'all else equal' - you should get really suspicious that it may be nonsense, because it's rarely ever true that all else is equal - it's a sleight-of-hand that many economic theories use, to try and get you to accept an assumption as true, when it is usually false (there are exceptions though - it is sometimes used legitimately - just keep your guard up).

Many people teaching this stuff will plead that the theories are not meant to be 'perfect' (a weasel-word used to imply that the theory is still mostly true and applicable/useful in the real world, even though it is not) - but that's another thing you should get incredibly suspicious of, because a lot of things taught should just be binned really - you want to be learning about real world economics, not about imaginary-world economic 'models', which actually do a really poor job of modelling how real economies work.

A fair number of the basics and principles you learn on a standard economic course, are all the building blocks of a wide range of economic models, which unfortunately don't actually represent reality very well at all - some of them are useful for learning purposes, but many are just plain misleading.

As the charter for this forum states, this is a forum for the discussion of Academic Economics, not soap boxing about percieved failings of academic economics that have little basis in reality. That post is not appropriate to this forum.

Geuze · 02-12-2015 1:32pm

Miss Informed wrote: »

Hey guys,

I'm confused about the law of supply;
"The law of supply is a fundamental principle of economic theory which states that, all else equal, an increase in price results in an increase in quantity supplied. In other words, there is a direct relationship between price and quantity: quantities respond in the same direction as price changes."

I've always associated higher quantities with lower prices and lower quantities with higher prices... Ie mass produced toys/watches = cheap, high quality watches, diamonds = expensive.

Think of housebuilding in Ireland - as prices go up, what happens to supply?

It reacts by rising.

Or think about, e.g. beef prices - if they rise, farmers react by producing more beef.

Geuze · 02-12-2015 1:40pm

KomradeBishop wrote: »

That's assuming that the increase in price is based on an increase in demand - so it's inherently violating 'all else equal' (as all else can not be equal, if demand needs to increase as well, for this to be true).

The supply/demand curve theory that you get taught in economics courses, is really flawed - there are a huge number of exceptions in the real world.
Here's an entire detailed post and comment section, arguing that in the real world, the supply curve tends to be flat - lots of good information there.

Note that plenty of economics books mention/discuss flat MC and supply curves.

It is a fair point that rising MC / supply curves may not always be realistic.

Speaking to engineers/managers about plant operations, they may tell you that MC does not rise as Q rises.

Law of supply

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