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 are almost always 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.

Graph depicting the effect of Supply Shock

BREAKING DOWN 'Supply Shock'

When output is increased, the price of the 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.

Examples of Supply Shocks

The global salmon industry is currently experiencing a supply shock. A deadly algae bloom had killed over 27 million salmon in Chilean salmon farms as of March 10, 2016. These salmon losses amounted to 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 has been the case in the copper industry since 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 global output. This decision comes 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, which, for the past decade, grew at an annual rate of over 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.

Events such as the recent flight of refugees from Syria caused a shock to labor supply in Syria, driving up prices. In addition, it has caused a demand shock in the countries the refugees are fleeing to, driving up prices of goods and services.

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