What is Oversupply
Oversupply is an excessive amount of a good or other substance. Oversupply results when demand is lower than supply, thus resulting in a surplus. There are many reasons why oversupply may occur. If there is demand for a specific product that meets a certain need, then the product might become oversupplied if a new and improved product is introduced that makes the older product obsolete. Oversupply can also occur in situations where the price of the good or service is too high, or above equilibrium.
BREAKING DOWN Oversupply
Although the context can vary, oversupply results from overproduction, which is the accumulation of unsalable inventories. The tendency for rampant overproduction of commodities to affect economic collapse is specific to a capitalist economy. In other types of economies, an abundance of production creates general prosperity. The difference is, in the capitalist economy, commodities are produced for profit. This so-called profit motive, the core of the capitalist economy, creates a dynamic whereby an abundance of commodities has negative consequences. In essence, an abundance of commodities disrupts the conditions for the creation of profit.
Price levels and oversupply exhibit a strong correlation. When a price is too high, demand will diminish while the quantity increases, eventually eclipsing that which is needed to serve demand. The occurrence of oversupply either leads to the lowering of the price or unsold supply. Lowering the price of a good encourages consumers to purchase more and suppliers to produce less.
Example of Oversupply Dynamics
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 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 increase their quantity demanded and producers cut production. Eventually, the market will achieve equilibrium price and quantity, absent the introduction of other external factors.
Oversupply in one market can affect supply or demand in another market. For example, high unemployment constrains consumer-laborers in their disposable income, which causes demand to decrease regardless of the price. This diminished goods demand resulting from a constraint in another market is known as the effective demand for goods.