What Is a Surplus? Definition, Reasons, and Consequences

What Is a Surplus?

A surplus describes the amount of an asset or resource that exceeds the portion that's actively utilized. A surplus can refer to a host of different items, including income, profits, capital, and goods. In the context of inventories, a surplus describes products that remain sitting on store shelves, unpurchased. In budgetary contexts, a surplus occurs when income earned exceeds expenses paid. A budget surplus can also occur within governments when there's leftover tax revenue after all government programs are fully financed.

Understanding a Surplus

A surplus isn't necessarily desirable. For example, a manufacturer who over-projects future demand for a given product may create too many unsold units, which may consequently contribute to quarterly or annual financial losses. A surplus of perishable commodities like grains could cause a permanent loss, as inventory spoils and the items become unsellable.

Economic Surplus

There are two types of economic surplus: consumer surplus and producer surplus. As a rule, consumer surplus and producer surplus are mutually exclusive, in that what's good for one is bad for the other.

Consumer Surplus

A consumer surplus occurs when the price for a product or service is lower than the highest price a consumer would willingly pay. Think of an auction, where a buyer holds in his mind a price limit he will not exceed, for a certain painting he fancies. A consumer surplus occurs if this buyer ultimately purchases the artwork for less than his predetermined limit. In another example, let's assume the price per barrel of oil drops, causing gas prices to dip below the price a driver is accustomed to shelling out at the pump. In this case, the consumer profits with a surplus.

Producer Surplus

A 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, if an auction house sets the opening bid at the lowest price it would comfortably sell a painting, a producer surplus occurs if buyers create a bidding war, thus causing the item to sell for a higher price, far above the opening minimum.

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. Hypothetically speaking, if there were a set price for a certain popular doll, that everyone was unanimously expected and willing to pay, neither a surplus nor a shortage would occur. But this rarely happens in practice, because various people and businesses have different price thresholds—both when buying and selling.

Sellers are constantly competing with other vendors to move as much product as possible, at the best value. If demand for the product spikes, the vendor offering the lowest price may run out of supply, which tends to result in general market price increases, causing a producer surplus. The opposite occurs if prices go down, and supply is high, but there is not enough demand, consequently resulting in a consumer surplus.

Surpluses often occur when the cost of a product is initially set too high, and nobody is willing to pay that price. In such instances, companies often sell the product at a lower cost than initially hoped, in order to move stock.

Results of Surplus

Surplus causes a market disequilibrium in the supply and demand of a product. This imbalance means that the product cannot efficiently flow through the market. Fortunately, 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 often results in higher price tags than consumers have been paying, thus benefiting the businesses.

More often than not, government intervention is not necessary, as this imbalance tends to naturally correct. When producers have a surplus of supply, they must sell the product at lower prices. Consequently, more consumers will purchase the product, now that it's cheaper. This results in supply shortages if producers cannot meet consumer demand. A shortage in supply causes prices to go back up, consequently causing consumers to turn away from the products because of high prices, and the cycle continues.

Surplus vs. Deficit

A deficit is essentially the opposite of a surplus. A deficit occurs when expenses exceed revenues, imports exceed exports or liabilities exceed assets, resulting in a negative balance. Just as a surplus is not always a positive sign, deficits are not always unintentional or the sign of a government or business that's in financial trouble. Businesses may deliberately run budget deficits to maximize future earnings opportunities—such as retaining employees during slow months to ensure themselves of an adequate workforce in busier times.

On the surface, a surplus is preferable to a deficit. However, this is an overly simplistic assumption. For example, a trade deficit is not inherently bad, as it can be indicative of a strong economy.

Deficits do carry risks if not handled properly or coupled with a large amount of debt. In the corporate world, running a deficit for too long a period can reduce the company's share value or even put it out of business.

The Bottom Line

A surplus, generally speaking, occurs when there is more of something than is needed. At first glance, that might sound like a positive for everyone. However, in reality, when there’s a disconnect between supply and demand, somebody inevitably suffers and it doesn't always end well.

For example, when a business has excess stock and is forced to cut prices to offload what it cannot sell, its profits tighten and its stakeholders suffer while consumers happily capitalize. Conversely, a producer surplus works the other way around, benefiting the business and squeezing the income of consumers. Ideally, a balance is struck to keep all parties happy. Sometimes market dynamics can stray, though, and lead to a nasty recession if equilibrium isn't restored in time.