Supply shock

A supply shock is an event that suddenly reduces the supply of a product or service in an economy, resulting in an increase in price. This event can be caused by a variety of reasons, including natural disasters, wars, or political changes. Supply shocks can lead to a decrease in consumer spending, an increase in unemployment, and a decrease in the overall output of a nation.

Examples of supply shocks include:

• Natural disasters: Natural disasters such as floods, earthquakes, and hurricanes can disrupt production, resulting in a decrease in the available supply of goods and services.
• Wars: Wars can often disrupt the production of essential goods and services, leading to shortages and supply disruptions.
• Political changes: Changes in government policies can also lead to supply shocks. For example, the imposition of trade tariffs or the introduction of new regulations can reduce the supply of certain goods and services.

Example of Supply shock

The OPEC oil embargo of 1973 is an example of a supply shock. The embargo, which was imposed by the Organization of Petroleum Exporting Countries, resulted in an oil shortage in the United States and other countries. This led to an increase in the price of oil and other energy sources, and had a significant impact on the global economy. The embargo caused a decrease in consumer spending, an increase in unemployment, and a decrease in the overall output of many countries.

When to use Supply shock idea

Supply shocks can be used to analyze the effects of a sudden change in the availability of goods or services on an economy. This type of analysis can be used to examine the impact of a variety of events, such as natural disasters, wars, or political changes, on an economy. By examining the effects of a supply shock, economists can better understand the impacts of these events on an economy, and can make more informed decisions about economic policy.

In addition, supply shocks can be used to measure the responsiveness of an economy to changes in supply. This type of analysis is often used to examine how markets respond to changes in supply, and can help to determine the level of government intervention that is needed in a particular market.

Types of Supply shock

A supply shock can be categorized into two types: demand-pull and cost-push.

• Demand-pull supply shock: This type of shock occurs when the demand for a good or service rises faster than the supply can meet it. This can lead to an increase in price and a decrease in the availability of the good or service.
• Cost-push supply shock: This type of shock occurs when the costs of production increase, leading to higher prices for the good or service. This type of shock can be caused by a variety of factors, including increases in the cost of inputs or labor, or changes in government policy.

Steps of Supply shock

The steps of a supply shock can be divided into three phases: the initial shock, the adjustment period, and the recovery period.

• Initial Shock: During this phase, the shock has just occurred, and the economy is adjusting to the sudden reduction in supply. Prices of goods and services will rise as demand outstrips supply, and unemployment will increase as workers are laid off.
• Adjustment Period: During this phase, the economy begins to adjust to the new supply and demand situation. Prices may continue to rise, and economic output may slow, but the economy is beginning to stabilize.
• Recovery Period: During this phase, the economy is beginning to recover from the shock. Prices and unemployment begin to return to normal levels, and economic output begins to grow again.

Possible advantages of Supply shock

Supply shocks can have some positive effects on the economy, including:

• Lower prices: A decrease in the supply of goods and services can lead to lower prices, which can benefit consumers.
• Increased production: In some cases, a supply shock can lead to an increase in production, as firms may be incentivized to increase output in order to meet the increased demand.
• Increased employment: Supply shocks can also lead to increased employment, as firms may be incentivized to hire more workers to meet the increased demand.

Limitations of Supply shock

The limitations of supply shock include:

• Difficulty in quantifying: Supply shocks can be difficult to quantify, as the effects may not be immediately apparent.
• Imprecise timing: Supply shocks may take some time to manifest, making it difficult to accurately predict the timing of their effects.
• Long-term effects: Supply shocks can also have long-term effects, such as reduced investment, as firms may be less likely to invest in an uncertain environment.

Other approaches related to Supply shock

• Demand-side policies: Demand-side policies, such as government spending and tax cuts, can help to mitigate the effects of a supply shock. These policies can help to boost consumer demand, leading to an increase in economic activity.
• Supply-side policies: Supply-side policies, such as the provision of subsidies or the removal of trade barriers, can also be used to help reduce the impact of a supply shock. These policies can help to increase the supply of goods and services, leading to a more efficient allocation of resources.

Supply shock — recommended articles

Change In Supply — Stabilization policy — Disinflation — Ratchet effect — Short run aggregate supply curve — Demand shock — Deflation gap — Demand-pull inflation — Crowding out effect

References

• Blinder, A. S., & Rudd, J. B. (2013). The supply-shock explanation of the great stagflation revisited. In The Great Inflation: The rebirth of modern central banking (pp. 119-175). University of Chicago Press.
• Asquith, B., Mast, E., & Reed, D. (2019). Supply shock versus demand shock: The local effects of new housing in low-income areas. Available at SSRN 3507532.