Equilibrium, Surplus, and Shortage
Demand and Supply
In order to understand market equilibrium, we need to start with the laws of demand and supply. Recall that the law of demand says that as price decreases, consumers demand a higher quantity. Similarly, the law of supply says that when price decreases, producers supply a lower quantity.
Because the graphs for demand and supply curves both have price on the vertical axis and quantity on the horizontal axis, the demand curve and supply curve for a particular good or service can appear on the same graph. Together, demand and supply determine the price and the quantity that will be bought and sold in a market. These relationships are shown as the demand and supply curves in Figure 1, which is based on the data in Table 1, below.
Price, Quantity Demanded, and Quantity Supplied
| Price (per gallon) | Quantity demanded (millions of gallons) | Quantity supplied (millions of gallons) |
|---|---|---|
| $1.00 | 800 | 500 |
| $1.20 | 700 | 550 |
| $1.40 | 600 | 600 |
| $1.60 | 550 | 640 |
| $1.80 | 500 | 680 |
| $2.00 | 460 | 700 |
| $2.20 | 420 | 720 |
If you look at either Figure 1 or Table 1, you’ll see that, at most prices, the amount that consumers want to buy (which we call quantity demanded) is different from the amount that producers want to sell (which we call quantity supplied). What does it mean when the quantity demanded and the quantity supplied aren’t the same? Answer: a surplus or a shortage.
Surplus or Excess Supply
Let’s consider one scenario in which the amount that producers want to sell doesn’t match the amount that consumers want to buy. Suppose that a market produces more than the quantity demanded. Let’s use our example of the price of a gallon of gasoline. Imagine that the price of a gallon of gasoline were $1.80 per gallon. This price is illustrated by the dashed horizontal line at the price of $1.80 per gallon in Figure 2, below.
At this price, the quantity demanded is 500 gallons, and the quantity of gasoline supplied is 680 gallons. You can also find these numbers in Table 1, above. Now, compare quantity demanded and quantity supplied at this price. Quantity supplied (680) is greater than quantity demanded (500). Or, to put it in words, the amount that producers want to sell is greater than the amount that consumers want to buy. We call this a situation of excess supply (since Qs > Qd) or a surplus. Note that whenever we compare supply and demand, it’s in the context of a specific price—in this case, $1.80 per gallon.
With a surplus, gasoline accumulates at gas stations, in tanker trucks, in pipelines, and at oil refineries. This accumulation puts pressure on gasoline sellers. If a surplus remains unsold, those firms involved in making and selling gasoline are not receiving enough cash to pay their workers and cover their expenses. In this situation, some producers and sellers will want to cut prices, because it is better to sell at a lower price than not to sell at all. Once so