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#Law of Supply: Definition - Example

Instructor: Tara Schofield

This lesson explains the law of supply. The connection between the law of supply and pricing is discussed. Several examples of provided to further explain the law of supply in action

What is Law of Supply?

Pricing is one of the biggest opportunities and one of the greatest challenges a company faces. If you are creating a price for a product, you must consider how much consumers are willing to pay without underpricing your product. Pricing is a critical aspect of the law of supply.

The law of supply is an economic principle that helps explain how to appropriately price products based on how much supply is available of a product. The law of supply explains that if people are willing to pay more money for a product, a company will produce or manufacture more of that product to capitalize on the increased revenue.

The opposite also holds true that as the price of a product drops, a company is likely to manufacture less of that product. In fact, if sales drop too far, the company may discontinue the product altogether.

There are times when a company may intentionally limit supply to cause the price of products to go up. Apple uses this kind of pricing strategy. When the iPhone 5 was released, there was not enough supply to meet the demand. Consumers were waiting outside Apple stores for days just in hopes they could be one of the lucky customers who left with a new phone on the release day. Because the demand was so high and the supply was restricted, Apple was able to charge a premium price and consumers gladly paid the full amount.

Example of Law of Supply

One example of the law of supply applies to fans of a football team who just won the championship to head to the Super Bowl. The week before the championship game, t-shirts and other items with the team logo were sold at typical prices that were equivalent to the prices of products with other team logos. However, once it's determined the team was headed to the Super Bowl, there is a run on the all of the team's merchandise. Retailers may double the price on the products and fans will continue to buy the products.

At the same time, retailers had increased their stock of the merchandise with the other team's logo in anticipation that they may be the winner of the championship game. However, once that team lost, fans were not clamoring to purchase their products. Therefore, the retailers had an overstock situation, causing the prices to be cut substantially in order to sell the excess inventory.