Mexico's lake of tequila

What happens when prices fail to adjust to a new equilibrium? Mexico found out the hard way at the end of last year, as the Financial Times reported in December (paywalled):

Mexico is sitting on more than half a billion litres of tequila in inventory, almost as much as its annual production, as the fast-growing industry reckons with slowing demand and the prospect of tariffs on exports to the US under Donald Trump.

By the end of 2023, the industry had 525mn litres of tequila in inventory, either ageing in barrels or waiting to be bottled, according to data shared with the Financial Times by the Tequila Regulatory Council. Of the 599mn litres of tequila produced last year, about one-sixth remained in inventory, according to the figures.

“Much more new spirit is being distilled than is being sold, and inventories are starting to accumulate,” said Bernstein analyst Trevor Stirling, attributing the build-up to falling demand and new distillery capacity that has recently begun operating in Mexico. “The tequila industry is set for a very turbulent 2025.”

Consider the market for tequila, as shown in the diagram below. The market was originally in equilibrium, where the supply curve S0 meets the demand curve D0, with an equilibrium price of P0 and Q0 units of tequila being traded. Then demand decreased to D1, and supply decreased to S1. The market should move to the new equilibrium, where the supply curve S1 meets the demand curve D1. However, say that the price remained at the original price P0 for a little while. What would happen?

If the price remained P0, the quantity of tequila supplied would increase to QS (because with the supply curve S1, the quantity supplied at the price P0 is equal to QS). The quantity of tequila demanded would decrease to QD (because with the supply curve D1, the quantity demanded at the price P0 is equal to QD). The difference between QS and QD is the quantity of tequila that remains unsold - a surplus, or excess supply. Or, as the FT article refers to it, a 'tequila lake'.

What happens next? In a market with excess supply, we would expect the price to adjust. Since tequila distilleries can't sell all of their tequila inventory, and it is costly to store it, they would start to lower the price. This 'bidding down of the price' by sellers would continue until the excess supply is eliminated. On the diagram above, that happens when the market gets to the new equilibrium, at the lower price P1, where Q1 tequila is traded.

And the FT article even notes some evidence that this adjustment is happening:

Two of the largest tequila brands, Bacardi-owned Patrón and Casamigos, which is now owned by London-listed Diageo, have been cutting prices for more than a year in response to weaker consumer demand, according to research by Bernstein.

Eventually, there would be no more tequila lake. Which is sad, because it calls to mind some interesting imagery. Here's what ChatGPT thinks a tequila lake looks like:

That's one way to get rid of the tequila lake, I guess!