What is a supply shock in economics? Definition and examples

Supply shocks can be positive or negative.

What are supply shocks? How do they affect prices?

When an event changes the availability of a product or commodity, its price generally increases or decreases accordingly. This situation is known as a supply shock. It is a temporary disruption that often occurs without warning, due to a one-time event, such as a grounded tanker preventing other vessels from accessing a trade route, or longer-term issues, such as a war, an embargo or a global health problem. crisis.

Although the expression sounds negative, favorable supply shocks do exist. Technological breakthroughs introduce new systems or innovations into an economy and can effectively lower prices. We will discuss both in more detail below.

Graph of negative and positive supply shocks

When supply decreases, prices increase, and vice versa

Supply shocks explained

The graphs above illustrate negative and positive supply shocks. In both charts, equilibrium is denoted by point A, production is denoted by the X axis, and prices are denoted by the Y axis. The chart on the left illustrates how a negative supply shock shifts the curve tender to the left, from line AS1 to AS2. In other words, exit, or the amount of something produced, becomes reduced. When this happens, as long as there is still demand for the product, prices (P) will rise sharply.

The chart on the right illustrates a favorable or positive supply shock. In this scenario, a positive supply shock shifts the supply curve to the right (line AS1 to AS2). Here, production is increased, and therefore, prices fall.

What is a concrete example of a positive supply shock?

A positive supply shock occurs when an event causes the production of a product or commodity to increase and thus become more readily available to mass markets. An example of this could be as simple as a favorable growing season for a vegetable like corn. When weather conditions are good, crop yields can be significantly higher than normal. Even if the demand for corn is unchanged, as long as there is an increase in production, the price of corn will fall.

Another example of a positive supply shock concerns the technology industry. In fact, this type is called technology shock. The rise of the Internet in the 1990s is an example of this, as it caused a paradigm shift in both the way news is presented (i.e. the 24-hour news cycle out of 24) and how the information is accessed (i.e. via search engines like Google). This positive supply shock effectively democratized knowledge, making it available instantly and at lower cost.

Other examples of technology shocks include the assembly-line production method pioneered by automobile manufacturer Henry Ford, as well as other advances made during the Industrial Revolution.

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What is an example of a negative supply shock?

Crude oil is often caught in the crosshairs of geopolitical tensions, and Russia’s unprovoked invasion of Ukraine in February 2022 was no exception. This incident – and the subsequent condemnation of countries around the world – led to embargoes on Russian crude oil. Russia is the world’s second largest oil exporter and as a result crude prices per barrel have skyrocketed over 40% from $73 per barrel in January 2022 to over $105 per barrel in March 2022.

Another example of a negative supply shock was related to the shortage of semiconductors that plagued the technology and automotive industries during the COVID-19 pandemic. Falling memory chip prices in 2018 and 2019 significantly reduced production. As the entire global workforce shifted to remote work during “stay at home” orders from March to June 2020, demand for these chips increased and prices soared to 20 %.

what Not a supply shock?

People might think that when a central bank, like the Federal Reserve, increases the money supply, a positive supply shock occurs. The central bank may aim to improve market liquidity by lowering interest rates or quantitative easing, making it easier for homeowners to get a mortgage or for a bank to make loans because that it has lower reserve requirements. However, although these measures are temporary and stimulate the economy, they have longer-term consequences, affecting prices, wages and, ultimately, the purchasing power of consumers.

Supply shocks like the fate of the Ever Given, the tanker that ran aground and blocked a single Suez Canal ship in July 2021, are actually happening, but they don’t have to be. long-term effects on employment or production. However, permanent supply shocks, such as paradigm shifts or stricter laws and regulations, can affect the economy as a whole. It is up to a central bank to use the tools at its disposal to combat supply shocks before they affect GDP growth and lead to more devastating long-term consequences, such as recession.

What causes supply shocks?

Any Disturbances, whether man-made, such as war, act of terrorism, or geopolitical event, or natural, such as an earthquake, hurricane, or drought, can drive a shock. supply. This disruption affects the production network between a company and its suppliers, which can impact many of the world’s most commonly used products. This network is known as the supply chain.

What are the effects of supply shocks?

Supply shocks may be temporary, but given aggregate demand, they can often cause prices to rise or fall dramatically. Positive supply shocks cause prices to fall, while negative supply shocks cause prices to skyrocket.

How do you resolve supply shocks?

The idiom goes that “time heals all wounds,” but when it comes to supply shocks, consumers expect central banks and those in power to act quickly to find a solution. Central banks can raise or lower interest rates and try other measures to stimulate economic growth or reduce unemployment. While there is no easy answer, it is important to remember that the nature of a supply shock is temporary and hopefully won’t last long.

Below are answers to some of the more common questions investors have about supply shocks that have not yet been addressed in the sections above.

Not always. Inflation simply means a period of rising prices. Crop failures and other natural disasters can affect food prices; however, when economists measure inflation, they are really talking about core inflation, which is the consumer price index minus food and energy prices, because they are so often volatile.

Do supply shocks contribute to stagflation?

Yes. Stagflation is a particularly nasty combination of inflation and high unemployment, plus a one-time event, like a war or an embargo, that makes it incredibly difficult for a central bank to control. The term itself is a mixture of the words “inflation” and “stagnation”.

Why can supply shocks lead to rationing?

When demand exceeds supply, the scarcer a product or commodity is, the higher its price will be. An authority may try to conserve resources by spreading their use over a period of time, known as rationing.

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