I have arrived at the price mechanism, how excess in demand drives prices up, and excess in supply drives them down – under normal circumstances and with everything else unchanged -, to end up at an equilibrium price and quantity cleared. But what happens to the excess supply, or the excess demand?
Certainly, people who cannot afford to pay, or do not want to pay, the market clearing price, all of a sudden lost their need or appetite for the product? Equally, what do suppliers do with the excess capacity that is not in demand?
Theory is, that suppliers with excess capacity will find other employment for idle capital, dismantle it, or sell it off. It may take some time for them to adapt, but eventually the excess capacity is either removed from the market, or kept idle while waiting for the market to attract again.
However, these options are not always that easy, as an example in the market for retail space in Tokyo shows. Tokyo has seen a large growth in the 50’s and 60’s1. When people founded families, they moved tot the suburbs, enticing retailers to establish outlets in the vicinity of potential customers.
But the Japanese population is ageing, while at the same time young people are less inclined to get married, and even if they are, they are even less inclined to found a family. Childless, there is no reason for them to live in the suburbs and travel the distance to the city centre, where their work is. Therefore they rent or buy studios and small apartments in town, and the suburbs are slowly abandoned, with no customers remaining for the shops. Furthermore, shop-owners are ageing too, many of them being in their 60’s or 70’s, without children who want to follow in their footsteps.
The deterioration in the service level of the suburbs created a downwards spiral: housing in these areas became less and less attractive for potential tenants and buyers. The prospect is, that within ten years shopping streets in suburbs will be totally abandoned – ghost streets. This is excess supply without demand – at any price. Therefore, the suburbs need restructuring, which will involve tearing down real estate that is out of demand.
How to use this in your lessons?
Difficulty with understanding the price mechanism may stem from both questions mentioned: what happens with excess supply and excess demand? Therefore, I would suggest to identify both questions, by putting them forward to your students.
- Source: Megastad Tokio sterft langzaam uit, (Megatown Tokyo is slowly deserted) Sacha Kester, De Volkskrant, 5 juli 2018