What is a Supply Shock?

A supply shock is an unexpected event that changes the supply of a product or a commodity, resulting in a sudden change in its price. Supply shocks can be negative (decreased supply) or positive (increased supply); however, they almost always are negative and rarely positive. Assuming aggregate demand is unchanged, a negative supply shock in a product or a commodity causes its price to spike upward while a positive supply shock exerts downward pressure on its price.

Supply Shock Explained

When output is increased, the price of a good decreases due to a shift in the supply curve to the right, and the reverse is true when output is decreased. Supply shocks can be created by any unexpected event that constrains output or disrupts the supply chain, including natural disasters and geopolitical developments such as acts of war or terrorism. A commodity that is widely perceived as the most vulnerable to negative supply shocks is crude oil because most of the world's supply comes from the volatile Middle East region.

Key Takeaways

  • Supply shocks can have a ripple effect. Storm damage and theft impacted the harvesting of vanilla beans in Madagascar, causing prices to spike in 2017 and 2018. This forced bakers and ice cream makers to raise prices or change recipes.
  • Money inflation can create a supply shock if the first people or businesses to benefit from the increase in cash subsequently increase their spending before the markets have time to adjust. Inventories then will decrease more quickly than typical, thus increasing demand.
  • The more flexible an industry is, the better it can adapt to a supply shock. If oil prices spike, the automakers that can most quickly and efficiently increase production of fuel-efficient vehicles will be the ones hurt the least.

Real World Examples of Supply Shocks

The global salmon industry experienced a supply shock in 2016. A deadly algae bloom had killed more than 27 million salmon in Chilean salmon farms as of March 10, 2016, resulting in a supply contraction of 6.8% in 2016.

The struggles of a single firm can cause a supply shock if the company is large enough. This was the case in the copper industry when Glencore announced in September 2015 its plans to close two major copper mines in the Democratic Republic of Congo and Zambia, removing 400,000 tonnes of copper from the global output. The decision came in response to a prolonged slump in copper prices. Therefore, this particular supply shock is considered beneficial by competing firms.

The fall in copper prices was caused by a slowdown in Chinese demand for copper. For the previous decade, demand had grown at an annual rate of more than 10% until it dropped to 3 to 4% in 2015. This highlights how a concentrated change in demand can influence prices. A change in demand must be abrupt and perceived as temporary to qualify as a shock, as is the case on the supply side.

When refugees began fleeing Syria in 2016, this caused a shock to labor supply in Syria, driving up prices. In addition, it caused a demand shock in the countries the refugees fled to, driving up prices of goods and services.