Excess Supply

Excess supply is a situation in which the quantity of a good or service that suppliers are willing to sell exceeds the quantity that buyers are willing to purchase at the prevailing price. Excess supply is the counterpart of excess demand, and it is a feature of markets that are not in equilibrium.

Definition

Excess supply exists when the price is above the level at which the quantity supplied equals the quantity demanded. At such a price, the quantity supplied exceeds the quantity demanded, and the difference is the excess supply.

In a competitive market, excess supply creates pressure for the price to fall, as suppliers compete to sell their output. As the price falls, the quantity supplied declines and the quantity demanded increases, until the two are equal and the market clears.

Causes

Excess supply can arise for several reasons. A price floor, such as a minimum wage or an agricultural support price, prevents the price from falling to the market-clearing level, leaving excess supply. A sudden fall in demand can create excess supply at the existing price, until the price adjusts.

Excess supply can also arise from a mismatch between the characteristics of the supply and the demand. If the goods offered do not match what consumers want, they may remain unsold even at prices that would clear a better-matched market.

The adjustment of prices may be slow, so that excess supply persists. In such cases, the market does not clear quickly, and the excess supply is resolved through other channels, including rationing, queuing, or the accumulation of inventories.

Consequences

The consequences of excess supply depend on the market. In product markets, excess supply leads to the accumulation of inventories, to price reductions, and to cuts in production and in employment. In labour markets, excess supply is unemployment, and it persists until wages adjust or until demand recovers.

Excess supply can be costly. It represents resources that are not being used and output that is not being sold. The costs fall on producers, who must reduce prices or output, and on workers, who may lose their jobs.

Excess supply can also have dynamic consequences. If prices and wages are rigid downward, excess supply can persist for a long time, and the resulting unemployment can erode skills and reduce the productive capacity of the economy.

Remedies

The remedies for excess supply depend on its cause. If it arises from a price floor, the remedy may be to remove the floor or to adjust it. If it arises from a fall in demand, the remedy may be to stimulate demand through fiscal or monetary policy.

If it arises from a mismatch between supply and demand, the remedy may be to adjust the supply, through retraining or through the reallocation of resources. The design of the remedy must take account of the costs of adjustment and of the distributional consequences.

Excess Supply in Labour Markets

Excess supply in the labour market is unemployment. It arises when the number of workers seeking jobs exceeds the number of vacancies at the prevailing wage. The excess supply persists when wages are rigid, so that they do not fall to clear the market.

The rigidity of wages may arise from institutional factors, including minimum wage laws, collective bargaining, and the reluctance of firms to cut wages for fear of harming morale and productivity. It may also arise from the behaviour of workers, who resist wage cuts.

The persistence of excess supply in the labour market has costs. The unemployed lose income and skills, and the economy loses output. The costs can be long-lasting, as the unemployed become detached from the labour market.

Excess Supply and Inventory

In product markets, excess supply leads to the accumulation of inventories. Firms that cannot sell their output at the prevailing price may hold it in inventory, hoping to sell it later, or they may cut prices.

The response depends on the nature of the good and on the costs of holding inventory. Goods that can be stored are more likely to be held, while perishable goods must be sold or discarded. The cost of storage affects the willingness of firms to hold inventory.

The accumulation of inventory is a signal of weak demand, and it often precedes a reduction in production and in employment. The inventory cycle is therefore an important element of the business cycle.

Excess Supply and Adjustment

The adjustment of markets with excess supply depends on the speed with which prices and quantities respond. In some markets, prices adjust quickly, and the excess supply is eliminated. In others, prices are rigid, and the adjustment occurs through quantities.

The speed of adjustment depends on the structure of the market and on the behaviour of the participants. In financial markets, prices adjust quickly, since the goods are homogeneous and the participants are well informed. In labour markets, adjustment is slower, since the goods are heterogeneous and the relationships are long-term.

The persistence of excess supply has implications for policy. If the adjustment is slow, there may be a role for policy to speed it up, for example by stimulating demand or by facilitating the reallocation of resources.

Summary

Excess supply is a feature of markets that are not in equilibrium, and it arises from price floors, from falls in demand, and from mismatches between supply and demand. Its consequences and its remedies depend on the market and on the speed of adjustment.

See also

• Microeconomics
• Market Structure
• Elasticity