What is a Surplus
A surplus is the amount of an asset or resource that exceeds the portion that is utilized. A surplus is used to describe many excess assets including income, profits, capital, and goods. A surplus often occurs in a budget, when expenses are less than the income taken in or in inventory when fewer supplies are used than were retained. Economic surplus is related to supply and demand.
BREAKING DOWN Surplus
A surplus isn't always a positive outcome. In some cases, when a manufacturer anticipates a high demand for a product that it produces and makes more than it sells during that time period, it can have a surplus inventory which may, if it's deep enough, lead to a financial loss for that quarter or year. When the surplus is of a perishable commodity, such as grain, it could result in a permanent loss, or an asset write-down as the inventory becomes bad.
An economic surplus is also known as total welfare. An economic surplus is related to money, and it reflects a gain in the expected income from a product. There are two types of economic surplus: consumer surplus and producer surplus.
Consumer surplus occurs when the price for a product or service is lower than the highest price the consumer would pay. For example, think of it as an auction: a buyer walks into an auction with a set price limit he or she will not exceed. Consumer surplus occurs if the buyer is able to purchase the product at a lower cost than this limit, which is seen as a gain. An example of consumer surplus in business and the global economy is oil prices - as the price per barrel drops below what the consumer is used to paying, the consumer profits with a surplus.
Producer surplus occurs when goods are sold at a higher price than the lowest price the producer was willing to sell for. In the same auction context, an auction house or auctioneer might set a low price for an item and start the bidding there, a price the house is not willing to go below. Producer surplus occurs if the auctioneer sells an item for a higher price than this low limit; for example, if buyers continue to bid for an item, raising the price until it is finally sold. This means the producer is making more money than expected.
As a rule, consumer surplus and producer surplus are mutually exclusive; what is good for one is not good for the other.
Other Types of Surplus
There are many types of surplus, but they are all closely related. An economic surplus is different from a surplus in supply; the former is positive, reflecting an increase in income, and the latter is negative, indicating there is too much stock on-hand and not enough demand (no one is buying the product). Consumer surplus often results in a shortage in supply for the producer, as it often means that the supply for the product cannot keep up with the demand, since people tend to buy more of a product that's sold at a good price. On the other hand, producer surplus often leads to a surplus in supply, indicating that prices might be too high.
Another type of surplus, budget surplus, occurs when income is higher than expenses, and it often deals with governments. A budget surplus is seen as positive, as it means the entity is using its money wisely. Budget surplus is the same as savings for an individual.
Reasons for Surplus
A surplus occurs when there is some sort of disconnect between supply and demand for a product, or when some people are willing to pay more for a product than others. For example, if there were a set price for the product, and everyone expected to pay the same amount, surplus and shortage would be nonexistent.
This doesn't tend to happen in the real world, however, because various people and businesses have different thresholds of price, both when buying and when selling. When selling goods, it is a constant competition to produce the best and the most, at the best value. As prices rise and fall based on supply and demand, surplus is created on the producer end and the consumer end, respectively. If demand for the product is high, the vendor offering the lowest price may run out of supply. This often results in an increase in general market price (producer surplus). The opposite is also true: prices tend to go down when supply is high but there is not enough demand (consumer surplus).
One common cause of surplus is that the cost of a product is initially set too high, and nobody is willing to pay that price. This isn't good for business, as many companies have no choice but to sell the product at a lower cost than they were initially willing, in order to get rid of the stock.
Results of Surplus
Surplus causes a market disequilibrium in the supply and demand of a product. This imbalance means that the product cannot flow through the market efficiently. However, the cycle of surplus and shortage has a way of balancing itself out.
Sometimes, to remedy this imbalance the government will step in and implement a price floor, or set a minimum price for which a good must be sold. This price is often higher than the price consumers have been paying, and therefore benefits the businesses.
More often than not, a government intervention is not necessary, as this imbalance tends to correct itself naturally: when producers have a surplus of supply, they have to sell the product at lower prices. Consequently, more consumers will purchase the product, since it no longer costs as much. This results in a shortage in supply, as the producer cannot keep up with consumer demand. A shortage in supply causes prices to go back up, and consequently, consumers no longer want the product because its price is too high; the cycle continues.