What is a 'Demand Shock'

A demand shock is a sudden surprise event that temporarily increases or decreases demand for goods or services. A positive demand shock increases demand, while a negative demand shock decreases demand. Both a positive demand shock and a negative demand shock have an effect on the prices of goods and services.

BREAKING DOWN 'Demand Shock'

A demand shock is a transitory disruption of market prices caused by an unexpected marking-shifting event that changes the perception of demand in regards to a specific good or a group of goods. Earthquakes, terrorist events, technological advances and government stimulus programs are all examples of events that can cause demand shocks.

When demand for a good or service increases (decreases) the price of that good or service typically increases (decreases) due to a shift in the demand curve to the right (left). This type of shock can come from such things as tax cuts or increases, loosening or tightening of the money supply, and increases or decreases in government spending. For example, a tax cut reduces the amount of money that taxpayers owe the government and frees up money for personal spending. This money is then used by taxpayers to consume certain products and services, which can cause prices to rise.

Positive and Negative Demand Shocks

A negative demand shock is a situation that occurs when an event causes fewer goods to be consumed, allowing the consumers who are still in the market to pay a lower price for the goods available. Conversely, a positive demand shock can come about when an event causes more goods to be consumed, driving up the price.

An Example of a Demand Shock

The rise of electric cars is a real-world example of a demand shock. It was hard to predict the demand for electric cars and, therefore, their component parts. Lithium batteries, for example, had low demand as recently as 2004. From 2004 to 2014, however, the rise in the demand for electric cars increased the overall market share of these cars to 3%, equal to roughly 2,100,000 cars.

This means, of course, that the demand for the lithium batteries that power these cars to sharply increase, somewhat unexpectedly, due to recent technological advancements. Over the period of 2004 to 2014, the production of lithium more than doubled, increasing the price per metric ton of lithium from $5,180 in 2011 to $6,600 in 2014. This increase in demand for electric cars increased the cost of component parts, and these rising costs are being passed onto the consumer, increasing the cost of electric cars in a positive demand shock environment.

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