Association of Chartered Certified Accountants (ACCA) Certification Practice Test

How does the concept of supply relate to price?

1. Higher prices lead to reduced supply

2. Supply is independent of price

3. Higher prices typically result in increased supply

4. Prices fluctuate regardless of supply levels

The correct answer is: Higher prices typically result in increased supply

The concept of supply is fundamentally linked to price through the law of supply, which states that, all else being equal, an increase in the price of a good or service will lead to an increase in the quantity supplied. This relationship arises from the incentive that higher prices create for producers. When prices rise, producers are motivated to increase production as they anticipate higher revenues and profits. This often involves investing in additional resources, hiring more workers, or optimizing production processes to meet the higher demand that comes with increased prices. Conversely, if prices fall, producers may reduce their output since the lower prices can make production less profitable or unprofitable. Thus, the mechanism of supply responds proactively to changes in price levels, reaffirming the connection between the two. This understanding is essential for analyzing market behaviors, as it illustrates how market prices influence the willingness and ability of producers to supply goods and services. In contrast, the other options suggest either a lack of relationship between supply and price or an inverse correlation, which is not aligned with basic economic principles regarding supply dynamics.