An economic surplus occurs when the quantity of a good or service available in a market exceeds consumer demand, resulting in unsold products. For instance, if a bakery makes 100 loaves of bread but only sells 70, the remaining 30 loaves represent a surplus. This situation arises from a disconnect between the amount produced and the amount purchased at a specific price.
The Relationship Between Supply and Demand
The concepts of supply and demand are foundational to understanding how a surplus occurs. In any market, there is a theoretical point of balance known as market equilibrium. This is the price at which the quantity of a product that producers are willing to sell perfectly matches the quantity that consumers are willing to buy. When a market is in equilibrium, resources are allocated efficiently.
A surplus is a state of disequilibrium that happens when the current market price is set above this equilibrium point. At this higher price, producers are incentivized to supply more of the product to maximize their potential revenue. Simultaneously, the higher price discourages consumers, who will purchase less than they would have at the equilibrium price, creating the imbalance.
Primary Factors That Create a Surplus
Government Intervention and Price Floors
One cause of a surplus is direct government intervention in the form of a price floor. A price floor is a legally mandated minimum price for a good or service, and to be effective, it must be set above the market equilibrium price. Governments implement these in agricultural markets to protect farmers or in labor markets through minimum wage laws. This artificially high price increases supply while decreasing demand, leading to a persistent surplus.
A Sudden Decrease in Demand
A surplus can also be triggered by a sudden drop in consumer demand for a product while the supply level remains constant. Such a “demand shock” can stem from a rapid change in consumer tastes or the introduction of a superior substitute product. For example, the development of flat-screen televisions caused demand for older, cathode-ray tube models to plummet, leaving a surplus of outdated units. An economic recession can also reduce consumers’ purchasing power, leading to a widespread surplus of various goods.
A Sudden Increase in Supply
Conversely, a market can be flooded with excess goods if supply suddenly increases faster than demand can absorb it. Technological advancements are a common driver, as a new, more efficient production method can lower costs and increase output. An influx of new producers entering the market can also ramp up the available quantity of a product. For example, new drilling technologies like fracking unlocked vast oil reserves, causing a global increase in oil supply that outpaced demand.
The Consequences of a Surplus
The most immediate consequence of a surplus is the downward pressure it exerts on prices. With unsold inventory, producers are motivated to lower their prices to attract more buyers and clear out the excess stock. This price drop benefits consumers, who can purchase the product for less, but it reduces profitability for producers.
Facing lower prices and reduced sales, businesses often cut back on future production to align with consumer demand. This can lead to a reduction in workforce or wages as companies adjust. For perishable goods, such as agricultural products, a surplus can lead to significant waste if items spoil before they can be sold. This entire cycle is a market correction mechanism, pushing the price and quantity back toward equilibrium.
Examples of Economic Surplus
A real-world example of economic surplus occurs in agriculture, driven by government policies. In the United States and the European Union, governments have set price floors for agricultural commodities like wheat and dairy to ensure farmers receive a stable income. Because these minimum prices are set above the market equilibrium, they lead to overproduction. This results in large surpluses that the government often has to purchase and store at taxpayer expense.
Another example was the global oil glut in the mid-2010s. The widespread adoption of hydraulic fracturing, or “fracking,” technology increased the supply of crude oil from the United States. This sudden surge in production was not met by a proportional increase in global demand. The resulting surplus caused oil prices to fall significantly, impacting the revenues of oil-producing nations and companies.