Supply Shock

A supply shock is a term used to indicate a sudden and unforeseen change in a commodity or service supply. The change can be an increase or decrease in the supply. Generally, the increase in supply results in a price decline, and a supply shortage causes a price rise.

It causes the price level and real output to move oppositely. For example, adverse or unfavorable supply shock drives the price up and output down. Supply shocks may have a short-lived influence on the economy or cause significant instability for a prolonged time. 

• A supply shock is an abrupt increase or decrease in the supply. It primarily influences the prices.
• There are two types of it: negative and positive. The former indicates a supply shortage and an increase in prices, and the latter indicates abundant supply and a decrease in the price of the goods. 
• The supply curve shifts to the left due to a negative shock, resulting in a supply fall and a price rise. The supply curve shifts to the right in case of positive type.

A supply shock is a significant change in the supply level of specific goods. It can be temporary or permanent based on the event triggering it. The most noticeable, coordinated, and frequent temporary shocks correlate with the seasons. The supply and demand disturbances occurring in the market even contribute to the existence of business cycle fluctuations.

The main shocks are increasing food prices, rising energy costs, and growing energy prices. They can also contribute to a drastic rise in inflation and affect the ability of businesses to create the gross domestic product (GDP) since the shock affect pricing and volume.

There are two types of supply shocks:

1. Negative Supply Shocks: The supply of the products reduces drastically, which leads to a rise in the price of products. Various factors reducing the supply include natural or artificial calamities, production difficulties, government policies, and political events.
2. Positive Supply Shocks: A positive supply shock happens when the output of a good or commodity increases rapidly and floods the market. Excessive supply crossing the demand results in a price drop. Conversely, the increase in output typically results from an increase in prices, profit, and low cost of production and technological breakthroughs that occur overnight and immediately increase both the return on capital and labor productivity. 

Let us look at supply shock examples to understand the concept better:

Example #1

The lowly chip, decades-old technology, has evolved from being an underappreciated component in powerful computers to being the most critical and costly component inside many contemporary products. This unanticipated surge in demand in specific sectors during the Covid-19 pandemic, including smartphones and computers, has resulted in a short-term supply shock that has led to an unconventional global scarcity. According to various reports, the lead times associated with order placing and filling extended to a significant number of weeks from normal levels.

Example #2

Geopolitical tensions frequently place petroleum products in the firing line, and Russia's invasion of Ukraine in February 2022 was no exception. For instance, Russia's crude oil was subject to export restrictions due to the invasion event and the subsequent international condemnation. Since Russia is the second-largest petroleum exporter in the world, the supply disruptions caused a more than 40% increase in oil prices, from $73 per barrel to over $105 per during the time of the invasion, which affected the economy of several countries that import the crude oil from Russia.

In the above negative supply shock graph, the equilibrium is point E1; the output is at the x-axis, and the price is at Y axis. The graph depicts how a negative shock shifts the supply curve to the left, from S1 to S2 (E1 to E2). As soon as the output/supply of the commodity decreases, the demand rises, and simultaneously it leads to an increase in the price of the goods.

In the positive supply shock graph, the equilibrium is point E1; the output is at the x-axis, and the price is at Y axis. The graph depicts how the positive type affects the supply curve to shift to the right from S1 to S2 (E1 to E2). As soon as the output/supply of the commodity increases, the demand decreases, and simultaneously it leads to a decrease in the price of the goods.

• Supply shocks occur due to disruption in the supply of goods due to unforeseen events such as natural disasters and geopolitical developments. In contrast, demand shocks are frequently thought to result from changing consumer preferences. Still, they may also be attributed to changes in other demand-related parameters, such as the cost of alternatives and complementary goods.
• Negative supply shock shifts the supply curve to the left; it causes supply to decrease and price to increase. Due to negative demand shock, fewer commodities are consumed, which can subsequently decrease the prices of the goods. 
• A positive supply shock comes from a rise in the supply of goods and services. Contrarily, positive demand shocks occur due to changes in fiscal policy, such as fiscal stimulus, tax cuts, expansionary monetary policy, etc. 

This article has been a guide to what is Supply Shock. Here, we explain its types (positive, negative), examples, graph, and differences with demand shock. You can learn more about it from the following articles –

• Economic Shock
• Demand Shock
• Stagflation