If you are interested in learning about the basic concepts of economics, you might have come across the terms law of supply and opportunity cost. These two concepts are closely related and help us understand how producers make decisions about what and how much to produce. In this article, we will explain what these terms mean and how they are connected.
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What is Law of Supply?
The law of supply is a microeconomic principle that states that, all other factors being equal, as the price of a good or service increases, the quantity of goods or services that suppliers offer will increase, and vice versa. In other words, there is a positive relationship between price and quantity supplied.
The law of supply can be illustrated by using a supply curve, which is a graph that shows the quantity supplied at each price. The supply curve slopes upward, meaning that as the price rises, suppliers are willing and able to produce more of the good or service.
The law of supply is based on the assumption that suppliers are rational and profit-seeking. They will try to maximize their revenue by selling more units at a higher price, or by reducing their costs by producing less units at a lower price. However, the law of supply also recognizes that there are limits to how much suppliers can produce, depending on their resources, technology, and other factors.
What is Opportunity Cost?
Opportunity cost is another important concept in economics that refers to the value of the next best alternative that is forgone as a result of making a decision. In other words, opportunity cost is what you give up when you choose one option over another.
For example, suppose you have $100 and you can either buy a new pair of shoes or invest it in a savings account that pays 10% interest per year. If you choose to buy the shoes, your opportunity cost is the $10 that you could have earned by investing the money. If you choose to invest the money, your opportunity cost is the satisfaction that you could have derived from wearing the new shoes.
Opportunity cost helps us measure the trade-offs involved in any decision. It also helps us realize that every choice has a cost, even if it is not obvious or monetary. By comparing the opportunity costs of different options, we can make more informed and rational decisions.
How is Law of Supply Related to Opportunity Cost?
The law of supply and opportunity cost are related because they both influence the production decisions of suppliers. The law of supply tells us that suppliers will produce more of a good or service when its price is higher, because they can earn more revenue. However, producing more also means incurring higher costs, such as using more resources, labor, capital, etc. These costs represent the opportunity costs of producing more units of the good or service.
For example, suppose a farmer can produce either wheat or corn on his land. If the price of wheat rises, he will be tempted to produce more wheat, because he can sell it for more money. However, producing more wheat also means using more land, seeds, fertilizer, water, etc., which could have been used to produce corn instead. The value of the corn that he could have produced is his opportunity cost of producing more wheat.
Therefore, suppliers will not produce infinitely more units of a good or service just because its price rises. They will compare the marginal revenue (the additional revenue from selling one more unit) with the marginal cost (the additional cost from producing one more unit), which includes the opportunity cost. They will produce up to the point where marginal revenue equals marginal cost, which is also where they maximize their profit.
According to Indeed, “The law of increasing cost is an economic principle that states that when a supplier increases the production of a good, the opportunity cost of producing additional goods also increases.” This means that as suppliers produce more units of a good or service, their marginal cost and opportunity cost will rise as well. This explains why the supply curve is upward sloping: as the price rises, suppliers need a higher incentive to produce more units and give up their next best alternative.
Conclusion
The law of supply and opportunity cost are two fundamental concepts in economics that help us understand how producers make decisions about what and how much to produce. The law of supply states that there is a positive relationship between price and quantity supplied: as the price rises, suppliers will produce more units to earn more revenue. Opportunity cost refers to the value of the next best alternative that is forgone as a result of making a decision: producing more units means giving up something else. Suppliers will compare their marginal revenue and marginal cost (which includes opportunity cost) to determine their optimal level of production and profit.
