In simple terms, excess supply means that there is a surplus of unsold goods in a market. Technically speaking, excess supply refers to a situation in which the quantity supplied of a good or service exceeds the quantity demanded for that good or service.
A graph may be helpful in understanding this concept. In the figure below, price (P) is plotted on the vertical axis and quantity (Q) is plotted on the horizontal axis. The curve labeled “supply” shows a positive relationship between the price and the quantity supplied. In other words, if the price goes up, firms are willing and able to produce more of the good. The curve labeled “demand” shows a negative or inverse relationship between price and the quantity demanded: If the price goes down, consumers are willing and able to buy more. The price labeled “Pe” equates the quantity supplied and the quantity demanded; there is no excess supply in this market. At the price labeled “Pf’,” the quantity supplied (Qs) exceeds the
quantity demanded (Qd), and thus there is a surplus or excess supply in amount Qs–Qd.
According to economic theory, if prices are sufficiently flexible, then excess supply should not persist in the long run. Faced with excess supply, firms will simply cut their prices in order to sell any unwanted inventory. However, government price controls can result in persistent excess supply. According to standard economic theory, a minimum wage may result in excess supply. If the minimum wage is set above the equilibrium wage (labeled “Pe” in the figure), the result is excess supply in the labor market or unemployment. If, however, the minimum wage is set below Pe, the minimum wage will have no effect on employment. To be effective, a minimum wage must be set above the equilibrium price.
Of course, governments can and do impose price controls in all sorts of markets. For example, governments often establish minimum prices for crops such as wheat, corn, and so on. To the extent that these price floors are effective, the result is excess supply, and governments find themselves storing large quantities of crops as a result. The European Union and the United States are often accused by developing countries of dumping the resulting surpluses on world markets, depressing the prices of such commodities and, as a result, lowering the incomes of farmers in developing countries.
Do minimum wages cause unemployment? In a seminal paper on the effect of the minimum wage, David Card and Alan B. Krueger (1994) use evidence from the fast-food industry and changes in the federal minimum wage in the United States to gauge the effect of the minimum wage on employment. In contrast to the predictions of the standard model that a minimum wage results in unemployment, they find no evidence that the minimum wages create unemployment. This paper has spawned a substantial literature attempting to replicate these results. Although the evidence is mixed, the general consensus appears to be that modest changes in the minimum wage do not appear to result in dramatic changes in employment, as perhaps economic theory may lead some to conclude.
SEE ALSO Barro-Grossman Model; Excess Demand; Flexibility; Market Clearing; Minimum Wage; Price vs. Quantity Adjustment; Supply; Tâtonnement
Card, David, and Alan B. Krueger. 1994. Minimum Wages and Employment: A Case Study of the Fast-Food Industry in New Jersey and Pennsylvania. The American Economic Review 84 (4): 772–793.