Supply shortage – What is it, definition and concept | 2022

Supply shortages occur when the quantity of goods and services put up for sale is insufficient to meet market demand.

That is, companies produce goods and services to offer them to the market. But then it turns out that these products are not enough to cover the needs and demands of consumers.

For example, we can analyze it in the oil market, where producing and exporting countries offer a specific number of barrels of oil. Then the countries that import or consume oil demand a certain amount of barrels that exceeds the amount that is put up for sale.

Supply Shortage 1
supply shortage
Why can there be a shortage of supply?

Why can there be a shortage of supply?

Of course, in order to understand why supply shortages occur, it is worth remembering two important points:

1. What bidders are willing to sell

In the first place, we must consider that the quantity of products that are sold in the market depends on what the producers are willing to sell. That is, a company that offers goods and services to the market must first produce them. Or, if it is a company that distributes them, it buys them from a company that produces them and then markets them.

Certainly, in any case, what we mean is that offering products to the market implies incurring production costs if it produces them. Similarly, it generates acquisition costs in the purchase, if the company resells them.

Therefore, if a company does not replace costs at the price established by the market, it is not willing to offer it because it would incur losses. The worst case scenario occurs when there are price cap policies and the government controls prices within the market.

In this case, the government sets prices below the equilibrium price, causing many suppliers to lose the ability to offer products on the market. Because, they do not recover their costs.

For example, if we analyze the following graph of the bread market. As we can see, the price established by the market is $0.35 per piece of bread. We can notice that in the upper part of the supply function or above the equilibrium price, we find producers who have costs higher than the sale price. For that reason they do not go out to sell their products.

However, this does not cause a shortage of supply. Because there is equilibrium in the market where the quantity supplied and demand coincide in 100,000 pieces of bread.

Supply Shortage 2
Example

However, the shortage of supply occurs when the government applies the price cap policy. Continuing with the example of the bread market, if the government applies a price ceiling of $0.25 per loaf of bread. In this case, we can see that the supply quantity of the producers that previously participated in the market at the price of $0.35 decreases from 100 thousand to 75 thousand pieces.

The reason is that all the suppliers that are located in the part between the equilibrium price and the price top of the supply curve, represent all the suppliers that now have costs higher than the price of $0.25.

Therefore, at this new price, these producers are no longer willing to go out and sell their products, because they would make losses. This upsets the market balance, because now the producers offer 75 thousand pieces of bread. Meanwhile, consumers intend to demand 125 thousand pieces of bread. Having as a consequence a shortage of supply because there would be a shortage of 50 thousand pieces of bread.

Supply Shortage 3
supply shortage
example by price

2. What the bidders are capable of producing

Secondly, it must be considered that the quantity of products offered to the market will depend on the production capacity of the suppliers. Here we are going to analyze that the shortage of supply is produced by the determinants of supply. These determinants affect the production capacity of producers.

Above all, we have to remember that the most important determinants of supply are:

  • The price of the factors of production.
  • The technological state.
  • natural factors.
  • The objectives of the company.

How do these determinants affect the production capacity of suppliers?

Continuing with the example, in the bread market, the baking companies could be affected by the increase in the prices of the factors of production. Such as the salary of bakers, the price of flour, the price of gas, the price of yeast, among some that we are going to mention.

Clearly, if the baking companies maintain the same level of financial capital to invest, the money is not enough to maintain the same level of production.

In the same way, regarding the technological state, the company may suffer drops in production. Because they can break down or they must give maintenance to the ovens or the machines that they use in their production process.

Likewise, natural factors can affect the production capacity of the company. If strong floods cause losses in wheat harvests, baking companies will not be able to count on the necessary inputs to maintain their production level.

Finally, the objectives of the company can affect the decrease in the company’s production. Companies can decrease their offer to see how the market reacts and achieve a price increase.

Consequently, in any of these cases what occurs is a shortage of supply, caused by a contraction of supply to the left. We can see this situation in the following graph.

Supply Shortage 4
supply shortage
Example by determinants

If we look at the graph, supply decreases causing a shortage of supply. This causes the balance point to change. Making the price increase to $0.45 and the equilibrium quantity decreases to 75 thousand pieces of bread.

In conclusion, it can be said that the shortage of supply is determined by what the producers are willing to sell according to the price of the product. As well as, by the capacity they have to produce according to the different determinants that affect supply.

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