I have a contention with the Law of Supply's dictum "if the price of a good falls, then the quantity supplied of that good falls, ceteris paribus."
Imagine a market for widgets produced by multiple factories with colossal machinery; the average cost differs among the factories.
If the price of the good decreases, then, according to the Law of Supply, quantity supplied decreases. The explanation I'm supposed to give in examinations goes along the lines of "the profit margin decreases, hence producers are incentivized to produce less".
Yet I would argue that, provided the drop in price is not drastic, every factory should produce the same amount as before, even those for which the price has dropped below the average cost, as this scenario would leave their owners better off compared to paying the fixed costs without revenue. Thus, the same quantity of widgets would be produced after the price drop.
The holes in my contention that are obvious to me are:
- If the decrease in price was drastic, then some owners would be obliged to shut down their factories.
- If the same machinery could be used to produce bananas instead of widgets, then the factories would switch to banana production if it yields more profit, thereby reducing the quantity of widgets supplied.
I also think that my argument is only valid in the short run: then, the marginal costs of individual firms would be more or less constant, and negligible changes in it would probably be brought about by small-scale laying off of employees. In the long run, owners could sell machinery and buildings and the marginal cost would be more variable.
So, taking account of all assumptions so far, i.e. the decrease in price is not drastic, the machinery is not good for anything other than producing widgets, and we are only considering the short run, then decreases in price should effect only slight changes in the quantity produced: this would be represented by a very inelastic supply curve. But, if interpreted as a marginal cost curve, this curve also says that for tiny nudges in the quantity produced, the marginal cost varies significantly, which is contrary to my earlier understanding that the marginal cost is approximately constant because factories cannot dump machinery easily in the short run.
What am I missing?