2.7.1 Definition of Surplus and Shortage

When a market price is not at the equilibrium level, it leads to an imbalance in the quantity supplied and the quantity demanded. These imbalances take the form of either a surplus or a shortage and create pressure for prices to adjust toward equilibrium.

Understanding market disequilibrium

In a competitive market, equilibrium occurs when the quantity demanded by consumers is exactly equal to the quantity supplied by producers at a particular price. This is known as the equilibrium price and the corresponding equilibrium quantity. At this point, there is no tendency for price to change because the market forces of supply and demand are balanced.

However, markets are constantly changing. Prices can move away from the equilibrium due to shifts in demand or supply, leading to a condition known as disequilibrium. When this happens, the quantity supplied and quantity demanded are no longer equal at the current price, which leads to one of two possible outcomes:

Surplus – too much of a good or service is available.
Shortage – too little of a good or service is available.

Understanding these concepts is essential for analyzing how real-world markets behave when they are not in balance.

What is a surplus?

A surplus occurs when the quantity supplied of a good or service is greater than the quantity demanded at a specific price. This situation arises when the market price is above the equilibrium level. Because producers are supplying more than consumers are willing to buy at that price, a surplus develops.

Key characteristics of a surplus

Excess supply: The amount producers are offering for sale exceeds what consumers want to purchase at that price.
Unsold inventory: Goods remain on store shelves or in warehouses because consumers are unwilling to pay the higher price.
Downward pressure on price: Sellers are motivated to reduce their prices in order to sell their excess stock.
Market self-correction: As prices fall, quantity demanded increases and quantity supplied decreases, gradually eliminating the surplus.

Why does surplus happen?

Several scenarios can lead to surplus conditions:

Price floors: A government-imposed minimum price, such as a minimum wage or agricultural price support, keeps the price above equilibrium.
Overproduction: Firms may produce more than the market can absorb, especially if they expect higher demand than actually materializes.
Fall in demand: A sudden decrease in consumer interest, perhaps due to changes in tastes or income, can lead to a mismatch between supply and demand.
Seasonal overstock: Industries like fashion or agriculture often experience surpluses after peak seasons.

Graphing a surplus

To visualize a surplus, use a basic supply and demand diagram:

The vertical axis represents price.
The horizontal axis represents quantity.
The demand curve (D) slopes downward.
The supply curve (S) slopes upward.
The equilibrium point is where the supply and demand curves intersect.
If a price above equilibrium is imposed, then:
- The quantity supplied (Qs) exceeds the quantity demanded (Qd).
- The horizontal distance between Qs and Qd at that price level shows the amount of the surplus.

Real-world example of a surplus

Suppose a video game console is priced at $600, but consumers are only willing to buy it at$ 400. At 1 per bottle after a natural disaster. At this low price, people want to buy 50 million bottles, but producers can only supply 35 million. This results in a shortage of 15 million bottles. Prices may rise due to bidding among consumers or scalping by third-party sellers, moving the market toward equilibrium.

How price responds to surplus and shortage

Prices are signals in a market economy. When a surplus or shortage exists, prices send a signal to buyers and sellers to adjust their behavior.

When there is a surplus:

Sellers lower prices to attract buyers.
As price decreases:
- Quantity demanded increases because consumers are more willing to buy at lower prices.
- Quantity supplied decreases because producers are less willing to supply at lower prices.
The surplus shrinks until the market reaches equilibrium.

When there is a shortage:

Buyers are willing to pay more, and sellers can raise prices.
As price increases:
- Quantity demanded decreases because some consumers can’t afford or don’t want the good at higher prices.
- Quantity supplied increases as producers are motivated by the higher profit potential.
The shortage shrinks as the market approaches equilibrium.

This process of price adjusting to eliminate surpluses and shortages is a fundamental concept in microeconomics and reflects the self-regulating nature of free markets.

Identifying surplus and shortage on graphs

On AP Microeconomics exams, students are often required to identify and explain surplus or shortage using a graph. Here's how to approach it:

Draw clearly labeled supply and demand curves with Price (P) on the vertical axis and Quantity (Q) on the horizontal axis.
Mark the equilibrium price (P*) and equilibrium quantity (Q*) where the supply and demand curves intersect.
If a price above P* is indicated:
- Qs > Qd, which shows a surplus.
If a price below P* is indicated:
- Qd > Qs, which shows a shortage.
Label the surplus or shortage area with a bracket or line to show the horizontal distance between Qs and Qd.

Understanding how to interpret these graphs is crucial for answering questions on market disequilibrium and price adjustments.

Examples from the real world

Surplus scenarios:

Minimum wage laws: If a government sets a minimum wage above the market equilibrium wage, more people are willing to work than there are jobs available. This creates a surplus of labor, also known as unemployment.
Post-holiday retail inventory: Retailers often overestimate holiday demand and are left with unsold goods after the season, leading to clearance sales.
Agricultural overproduction: Farmers may produce more wheat or corn than consumers are willing to buy, especially if weather conditions are favorable.

Shortage scenarios:

Rent-controlled apartments: When rent ceilings are set below equilibrium, more people want to rent apartments than there are units available, creating a housing shortage.
Emergency supply shortages: During pandemics or natural disasters, demand for items like hand sanitizer or gasoline spikes, leading to empty shelves and long waits.

Limited-edition products: Popular tech gadgets or sneakers released at a low price often sell out quickly, leading to resale markets where prices are much higher.

FAQ

A single market cannot experience both a surplus and a shortage of the same good at the same price simultaneously. However, confusion sometimes arises when looking at different segments of the same market. For example, a surplus might occur in one geographical area while a shortage happens in another due to transportation issues, price controls, or local demand spikes. Additionally, in more complex markets like labor or housing, there can be a surplus of certain types (e.g., unskilled labor) while there is a shortage of others (e.g., skilled labor). This is often referred to as a mismatch in the market rather than a true simultaneous surplus and shortage. Still, at a specific price in a single, unified market, only one condition—either a surplus or a shortage—can exist. This is because the market price being either above or below equilibrium determines only one type of disequilibrium at a time.

In theory, surpluses and shortages are temporary because prices adjust to restore equilibrium. However, in practice, several factors slow down or prevent this adjustment. First, price stickiness—the resistance to changing prices—can delay adjustments. This stickiness can result from menu costs (the costs of changing prices), contracts, or a desire to maintain customer loyalty. Second, government intervention, such as price floors or ceilings, can legally prevent prices from moving toward equilibrium. Third, imperfect information can make it hard for buyers and sellers to recognize the imbalance and adjust behavior accordingly. Also, in some industries like housing or agriculture, production lags make it difficult to quickly respond to changing market conditions. Psychological and behavioral factors, such as anchoring or fear of losing market share, may also prevent producers or consumers from responding immediately. These real-world complexities mean that disequilibrium can persist longer than economic models suggest.

Expectations about future prices can significantly influence present-day supply and demand, potentially creating or worsening surplus or shortage conditions. If consumers expect prices to rise, they may increase current demand, leading to a temporary shortage. On the supply side, if producers anticipate higher future prices, they may withhold supply now to sell later at a better profit, also contributing to a shortage in the short run. Conversely, if future prices are expected to fall, consumers might delay purchases, reducing demand and leading to a surplus. Producers might try to sell quickly before prices drop, increasing current supply and worsening the surplus. These anticipatory behaviors can cause the market to deviate from equilibrium. Expectations are particularly impactful in markets with volatile pricing, like oil, real estate, and commodities. Since expectations are based on beliefs about future conditions, they can be self-fulfilling, making them a powerful force in market dynamics.

Yes, a surplus or shortage can exist even when there are no visible signs of market failure. This is especially true when prices are artificially constrained or if secondary markets develop. For example, in a labor market with a minimum wage set above equilibrium, unemployment (a labor surplus) may not be immediately apparent if people stop actively searching for work or take part-time jobs instead. In product markets, black markets or waiting lists may signal an underlying shortage despite stores appearing orderly. Similarly, a surplus of goods may be hidden by inventory storage or discounting strategies that delay price reductions. In addition, if the market is not perfectly competitive—such as with monopolistic or oligopolistic firms—prices may not reflect true supply and demand conditions, and surpluses or shortages may persist quietly. Therefore, just because transactions continue to occur smoothly doesn't mean the market is at equilibrium.

When a shortage occurs and prices cannot rise due to a price ceiling or other constraint, markets often turn to non-price rationing mechanisms to allocate scarce resources. These methods include waiting lines, lotteries, ration coupons, or first-come, first-served systems. For example, during fuel shortages, consumers may be limited to purchasing gas on certain days or in fixed amounts. These mechanisms are often seen as more equitable than allowing prices to rise, but they come with efficiency costs. Non-price rationing does not ensure that goods go to those who value them most highly, which is something the price mechanism naturally does. Additionally, such systems may encourage hoarding, reselling at higher prices (black markets), and unproductive time costs, like standing in line. While non-price rationing may achieve political or social goals, it often leads to misallocation of resources and deadweight loss, reducing the overall efficiency of the market.

Practice Questions

Assume the current market price of apples is set above the equilibrium price. Using a correctly labeled supply and demand graph, explain what will happen in the market for apples and how the market will adjust over time.

When the price of apples is set above equilibrium, a surplus occurs because the quantity supplied exceeds the quantity demanded. Producers will notice unsold apples accumulating and begin to lower prices to attract buyers. As the price falls, consumers demand more apples and producers reduce the quantity supplied. This movement continues until the market price returns to equilibrium, where quantity demanded equals quantity supplied. The self-correcting mechanism ensures that the surplus is eliminated and the market clears at the equilibrium price and quantity.

A severe shortage of gasoline develops in a city due to a price ceiling imposed below the equilibrium price. Explain what causes the shortage and how market forces would act to eliminate it if the price ceiling were removed.

The shortage is caused because the price ceiling prevents gasoline from being sold at the equilibrium price, leading to quantity demanded exceeding quantity supplied. Consumers want more gasoline at the lower price, but producers are unwilling to supply enough to meet that demand. If the price ceiling were removed, gasoline prices would rise. As the price increases, quantity demanded would fall and quantity supplied would rise. Eventually, the market would reach a new equilibrium where quantity demanded equals quantity supplied, and the shortage would be eliminated through the natural forces of supply and demand.

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