What is Oversupply?

Oversupply is an excessive amount of a product. Oversupply results when demand is lower than supply, resulting in a surplus. Simply put, an oversupply is when there is more product for sale than people are prepared to buy. There are many reasons why oversupply may occur. There can be an oversupply of a current product due to people waiting for an improved model in a series, such as smartphones from a particular maker. Oversupply can also occur in situations where the price of the good or service is too high and people are simply not prepared to buy it at that price. An oversupply may also simply be a case of a producer completely misreading the market demand for a product.

Key Takeaways

  • Oversupply is a situation where there is more product on the market than consumers want to buy.
  • In commodities, an oversupply is a period when over production of a commodity pushes the price for that commodity down to a level where the producers are losing money.
  • Oversupply tends to be corrected through reduced production or discounting, but the time period over which this happens can be quite long depending on the dynamics of the market.

Understanding Oversupply

Although the context can vary, oversupply results from overproduction and leads to the accumulation of unsalable inventories. Price levels and oversupply are strongly correlated.

When a price is too high, demand will diminish and the unsold quantity will increase unless the producer discounts the good or halts production. Discounting product is the most obvious way to deal with an oversupply, and it is often the only way to clear unsold inventory if new product is on its way. Discounting does impact the bottom line of the seller and the seller may have agreements that share that pain back with the producer.

In commodity markets, oversupply is more of a market condition than a problem to be solved. For commodities like oil, natural gas, precious metals, meat and so on, the production timeline requires a significant lead time and the prices are all market-based. If, for example, a number of large scale gas fields begin production at the same time, there will be an oversupply of natural gas on the market leading to a lower price. During periods of oversupply, producers may actually lose money on the units they are selling.

The interesting thing about some types of commodity oversupply is that it is not a matter of unsold inventory, but how much of the commodity can be stored and stockpiled before it eventually sells at whatever the market will pay. Because production cannot be easily dialed up and down, commodity producers depend on storage to help remove supply from the market while production cycles adjust to the longer-term lower demand. Of course, if too much production is curtailed, then the market will be undersupplied and more investment will flow into the production side. This is one of the many reasons that many commodities have cyclical boom and bust pricing charts.

Example of Oversupply Dynamics

Oversupply and its impact on market equilibrium is best understood through an example. Suppose the price of a computer is $600 at a volume of 1,000 units, but demand only requires 300 units. In such a situation, sellers are seeking to sell 700 more computers than buyers are willing to purchase. The oversupply of 700 puts the market for computers in disequilibrium. Since they're not able to sell all the computers for the desired price of $600, sellers consider a price reduction to make the product more attractive to buyers. In response to the reduction in the price of the product, consumers demand increases and producers cut production. Eventually, the market will achieve equilibrium price and quantity, absent the introduction of other external factors, see also Walrus' law