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Let's assume that there is disequilibrium, namely that $P=P_2$, thus $Q_s > Q_d$. In other words, there is overproduction. This is perfectly competitive market, so competition between producers will make them lower prices in order to get rid of excessive production, thus allowing the market equilibrium (in the point $E$) to be reached. But wait a second! When we said that producers will change price we said nothing about quantity of production. But you can clearly see that in point $L$ (before producers lowered prices) the quantity was equal to $Q_2$, while in point $E$ it's equal to $Q'$, and $Q' < Q_2$.

What happened with all these ${\bf Q}_2$ minus ${\bf Q}'$ goods? It looks like producers collectively decided to destroy part of their excessive goods in order to reach the point of equilibrium. Because if producers will change only price of their goods (i.e. $Q_s$ is constant) there is NO way they can reach equilibrium without moving their supply curve (or alternatively - without moving the demand curve).

  • $\begingroup$ Are you assuming that the goods are non-perishable? $\endgroup$ – Adam Bailey Jan 18 '18 at 10:46
  • $\begingroup$ Yes, you are correct. $\endgroup$ – user161005 Jan 18 '18 at 13:23

The Econ 101 demand-and-supply story serves to illustrate a simple point: Markets tend to move/adjust towards equilibrium. However, such adjustment is neither instantaneous nor perfect; rather, it takes time.

For simplicity, let's first imagine we have perishable goods that must be consumed by the end of each day. On Day 1, producers set the price too high at $P_2$ and there is excess supply AL. And so at the end of Day 1, producers end up with AL units of unsold (and wasted) goods.

On Day 2 then, producers will probably wisen up a little. They'll probably produce a little less and reduce the price by a little, so that excess supply is reduced by at least a little.

If on Day 2 there is still excess supply, then on Day 3 we'll see still further reductions in quantity produced and prices, and hence a still further reduction in excess supply.

This common-sense story tells us that over time, the market will tend to move towards equilibrium. However, this adjustment process is neither instantaneous nor perfect. It happens gradually, over time.

In the case of non-perishable goods, the adjustment process will likely even be slower, because, as you rightly point out, there is now the possibility that producers can store their inventories and sell today's unsold goods tomorrow. The $Q_2 - Q_1$ goods can indeed be stored and we can try to sell them tomorrow.

However, it is not free to store inventories. If every day producers produce $Q_2 = 1,000$ units but consumers buy only $Q_1 = 600$, then each day we'll add another $Q_2 - Q_1 = 400$ units to our inventories. Our inventories will keep piling up.

And so over time, even with the possibility of storing inventories, producers will recognize there is persistent excess supply, wisen up, and gradually reduce the quantity they produce and also their prices. Excess supply will thereby gradually be reduced.

The story is the same whether goods are perishable or non-perishable. The only difference here is that we'd expect a market for perishable goods to adjust more rapidly towards equilibrium.

  • $\begingroup$ It's adaptation during several productional cycles, while I assumed only one. Is it possible for producers to reach equilibrium in case of overproduction BEFORE their new production cycle begins? Like if they produce once per month can they reach equilibrium before the month is over? $\endgroup$ – user161005 Jan 19 '18 at 15:20
  • $\begingroup$ @user161005: It's possible to come up with a story where the answer to your question is "yes". (E.g. Define equilibrium as a monthly thing, so that if QS = QD for that month, we say that equilibrium is achieved. Then if at the start of the month, producers set the price too high, they could later in the month lower the price so that at the end of the month we have exactly QS = QD.) $\endgroup$ – user18 Jan 20 '18 at 1:00
  • $\begingroup$ But I wouldn't take the concept of equilibrium too literally or precisely. Again, equilibrium is merely a tendency. Markets are constantly moving towards equilibrium, but are rarely in equilibrium. One reason for this is that conditions are always changing. (This though is merely my view and that of some others. Some economists assume that markets are always and everywhere in equilibrium, though usually this assumption is for the purposes of theoretical simplicity and I don't think they literally believe it.) $\endgroup$ – user18 Jan 20 '18 at 1:00
  • $\begingroup$ See this brief discussion which argues economists have 3 possible views on equilibrium: "1. Equilibrium is a useful concept, and the economy will tend toward an equilibrium. 2. The economy is always in equilibrium. 3. Equilibrium is not a useful concept, as the economy is always on a dynamic path that does not tend toward any equilibrium." I suppose I would fall under #1. $\endgroup$ – user18 Jan 20 '18 at 1:10

You are basically asking a dynamic question on the basis of a static model, although this often done for convenience. In a real static model, over production is impossible.

You answered the first part of your question yourself: In the short run the Q2-Q'goods got sold off at a lower price. For the long run: recall that the supply curve is also the industry's marginal cost curve. If producers lower their prices below P2, some of them will start to operate at less than max profit and either go out of business or reduce production, to operate at max profit level again. In the long run we thus move along the supply curve, downwards to point E.

  • $\begingroup$ "You are asking a dynamic question on the basis of a static model". What does it mean? "In a real static model, over production is impossible." Why? "In the short run the Q2-Q'goods got sold off at a lower price." So what? People who will buy excess goods will satisfy their demand, thus making remaining goods excess because there will be less people willing to buy them. $\endgroup$ – user161005 Jan 18 '18 at 15:16
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    $\begingroup$ Given your picture, the original model is of the form Qd=a-bP, Qs=c+dP, that is there is no time dimension involved. Price and quantity adjustments happen instantly. Overproduction is impossible because prices and quantities immediately adjust, and shoot back to equilibrium. Given the lower price more people buy the good. The only price at which producers can sell the excess at Q2 is price P1, They might want a higher price but they won't be able to sell Q2 if they don't lower the price until P1, thus increasing quantity demand to Q2, at which point the long run from above kicks in $\endgroup$ – Maarten Punt Jan 18 '18 at 15:53
  • $\begingroup$ "Price and quantity adjustments happen instantly. " So what? In order to adjust (no matter how fast) Q producers must collectively decide to destroy excessive goods, NOT sell them. But it would be illegal. Just selling them off for lower prices would make remaining goods excessive because it will increase satisfaction of consumers for the goods. Probably producers in this situation just should sell ALL their goods at P=P1, and next time produce less. $\endgroup$ – user161005 Jan 19 '18 at 7:29

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