A2.01.05: The Law of Supply

Question 1

What is the law of supply

Answer 1

as the price of a product rises, the quantity supplied of the product will usually increase, ceteris paribus

(directly proportional relationship)

Question 2

What 3 things prove that the law of supply holds?

Answer 2

• The profit motive
• Production costs
• New firms entering the market

Question 3

How does profit motive prove the law of supply

Answer 3

• if price increases (following demand increases)
• it becomes more profitable to supply (following costs of production remain low)
• therefore output increases

Question 4

How do production costs prove the law of supply

Answer 4

• if output increases, production costs increase
• firms increase their prices to offset the extra costs incurred
• may be due to the effects of diminishing returns as more factor inputs are added to production

Question 5

How do new firms entering the market prove the law of supply

Answer 5

• Prices increasing creates incentives for other firms to enter the market
• This is because it means more profits are being made in the long-run
• Therefore, quantity supplied increases