Equilibrium, Excess Demand and Supply

Excess demand and supply : In economics, equilibrium, excess demand and supply are fundamental concepts that shape market dynamics. Equilibrium represents a state of balance where the quantity demanded equals the quantity supplied. However, markets often experience imbalances, leading to excess demand and supply. Excess demand occurs when the quantity demanded exceeds the quantity supplied at the prevailing price, causing shortages and price increases. However, excess supply arises when the quantity supplied surpasses demand, resulting in surpluses and price decreases.

What is Equilibrium?

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Definition Of Excess Demand

Effects Of Excess Demand On The Market

• Price Increase : In a market economy, prices act as a signal to both producers and consumers. With excess demand, businesses can earn higher profits by raising the price. This discourages some consumers from buying due to the higher cost, effectively reducing demand and bringing it closer to the available supply.
• Shortage of Goods : When demand significantly outstrips supply, there might not be enough products for everyone who wants them. This can lead to stockouts, where stores run out of inventory, and frustration among consumers who cannot find the desired product.
• Increased Production : High demand can be a positive signal for businesses. It indicates a strong market for their products, and they might be incentivised to increase production to meet consumer needs. This can lead to increased investment, hiring, and economic growth.
• Search Costs : With excess demand, consumers might have to put in more effort to find the desired product. This could involve visiting multiple stores, searching online marketplaces, or even paying a premium to secure the item from resellers.
• Black Markets : Black markets can emerge in extreme cases of excess demand and limited supply. These are illegal marketplaces where scarce goods are traded at exorbitant prices.

Also Read: 4 Important Principles of Scientific Management

What Is Excess Supply

Effects Of Excess Supply On The Market

• Price Decrease : In a market economy, prices are influenced by supply and demand. With excess supply, businesses face pressure to sell their inventory. One way to attract buyers is to lower the price. This can incentivise consumers to buy more, bringing supply and demand closer to equilibrium.
• Reduced Production : When there is a consistent surplus of goods, businesses might see a decline in profits due to lower prices. This can lead them to cut back on production to avoid further losses. Reduced production can ripple effect, impacting employment and overall economic activity.
• Innovation and Differentiation : Facing excess supply, businesses might be forced to innovate and differentiate their products or services to stand out in a crowded market. This could involve introducing new features, improving quality, or focusing on better marketing strategies to attract customers.
• Increased Competition : Excess supply can intensify competition among businesses. They might vie for customers through aggressive marketing campaigns, offering discounts, or introducing loyalty programs to attract buyers and sell their stock.
• Stockouts of Complementary Goods : In some cases, an excess supply of goods can lead to stockouts of complementary goods. This can happen if the price of the good falls significantly, making it less profitable to produce the complementary good.

Factors Influencing Excess Supply and Demand

• Consumer Preferences : Consumer tastes and preferences changes can significantly impact supply and demand. For example, if people suddenly prefer electric cars over petrol, the demand for electric cars will increase, while the demand for petrol cars may decrease.
• Income Levels : The amount of money people spend affects their purchasing power and, consequently, their demand for goods and services. Higher incomes often lead to increased demand for luxury items and leisure activities.
• Prices of Related Goods : The prices of related goods can influence demand. For example, if the price of tea increases, some consumers may switch to coffee as a substitute, leading to an increase in demand for coffee.
• Population Changes : Population size, demographics, and age distribution can impact supply and demand. A growing population may increase the demand for housing, while an ageing population may increase the demand for healthcare services.
• Production Costs : Changes in production costs, including raw materials, labour, and technology, can affect the supply of goods and services . For example, if the cost of oil increases, the cost of producing plastic goods may also rise, leading to a decrease in supply.
• Government Policies : Government policies, such as taxes, subsidies, and regulations, can influence supply and demand. For instance, subsidies for renewable energy may increase the supply of renewable energy sources, while taxes on sugary drinks may decrease demand.
• External Factors : External factors such as natural disasters, technological advancements, and global economic conditions can also impact supply and demand. For example, a drought may reduce the supply of agricultural products, leading to higher prices and lower demand.

Market Equilibrium Under Perfect Competition

How Does This Equilibrium Resist Any Change?