What Is a Demand Shock?
A demand shock is a sudden unexpected event that dramatically increases or decreases demand for a product or service, usually temporarily. A positive demand shock is a sudden increase in demand, while a negative demand shock is a decrease in demand. Either shock will have an effect on the prices of the product or service.
A demand shock may be contrasted with a supply shock, which is a sudden change in the supply of a product or service that causes an observable economic effect.
Supply and demand shocks are examples of economic shocks.
- A demand shock is a sharp, sudden change in the demand for a product or service.
- A positive demand shock will cause a shortage and drive the price higher, while a negative shock will lead to oversupply and a lower price.
- Demand shocks are usually short-lived, but can have longer-term consequences.
Understanding a Demand Shock
A demand shock is a large but transitory disruption of the market price for a product or service, caused by an unexpected event that changes the perception and demand.
An earthquake, a terrorist event, a technological advance, and a government stimulus program can all cause a demand shock. So can a negative review, a product recall, or a surprising news event.
Supply and Demand
When the demand for a good or service rapidly increases, its price typically increases because suppliers cannot cope with the increased demand. In economic terms, this results in a shift in the demand curve to the right. A sudden drop in demand causes the opposite to happen. The supply in place is too great for the demand.
Other demand shocks can come from the anticipation of a natural disaster or climate event, such as a run on bottled water, backup generators, or electric fans.
A positive demand shock can come from fiscal policy, such as an economic stimulus or tax cuts. Negative demand shocks can come from contractionary policy, such as tightening the money supply or decreasing government spending. Whether positive or negative, these may be considered deliberate shocks to the system.
Examples of Demand Shocks
The rise of electric cars over the past few years is a real-world example of a demand shock. It was hard to predict the demand for electric cars and, therefore, for their component parts. Lithium batteries, for example, had low demand as recently as the mid-2000s.
From 2010, the rise in the demand for electric cars from companies like Tesla Motors increased the overall market share of these cars to 3 percent, or roughly 2,100,000 vehicles. The demand for lithium batteries to power the cars also increased sharply, and somewhat unexpectedly.
The Lithium Shortage
Lithium is a limited natural resource that is difficult to extract and found only in certain parts of the world. Production has been unable to keep up with the growth in demand, and so the supply of newly mined lithium remains lower than it would be otherwise. The result is a demand shock.
Over the period from 2016 to 2018, demand for lithium more than doubled, increasing the average price per metric ton from $8,650 in 2016 to $17,000 in 2018. Over the past decade, the increase in demand for electric cars from companies like Tesla Motors (TSLA) has increased the overall market share of these cars to more than 4% of car sales in 2022. The demand for lithium batteries to power the cars also increased sharply, and somewhat unexpectedly.
During this time, demand exploded for electric vehicles and also battery-powered mobile phones, laptops, and tablets.
From 2020 to 2022, the price of lithium has more than doubled again. This is because the COVID-19 pandemic initially caused a decrease in demand that caused the price of a metric ton of Li to fall to $8,000. However, as the economy recovered, the price quickly spiked to $17,000 once again by the end of 2021. The cost has been passed onto the consumer, raising the cost of electric cars in a positive demand shock environment.
A Negative Demand Shock
The cathode ray tube is an example of a negative demand shock. The introduction of low-cost flat-screen televisions caused the demand for cathode-ray tube TVs and computer screens to drop to nearly zero in a few short years. Not incidentally, the introduction of low-cost flat screens caused a once-common service job, the television repairman, to become virtually extinct.
How Does a Demand Shock Differ From a Supply Shock?
A demand shock occurs when there is an unexpected change in demand, such that suppliers cannot quickly enough respond. A supply shock, on the other hand, is when there is an unexpected change in supply (often a sudden reduction, although supply shocks also exist when there is a glut).
What Can Cause a Demand Shock?
Demand shocks may be caused for one or more of several reasons. An economic recession may lead to high unemployment, where people are unable to spend as they had before. Natural or geopolitical disasters can also have a similar effect in the short run. Demand shocks can also occur if a technological advance makes a previous technology quickly obsolete.
Did Government Stimulus Checks Create a Demand Shock?
In the wake of the COVID-19 pandemic, the U.S. government issued a series of stimulus checks to American households. The goal was to help families cope with lockdowns, business closures, and other disruptions. However, these checks also may have been a positive demand shock, boosting spending by too much as the economy recovered and leading to high inflation.