What Is Supply Shock?
A supply shock is an unexpected event that suddenly changes the supply of a product or commodity, resulting in an unforeseen change in price. Supply shocks can be negative, resulting in a decreased supply, or positive, yielding an increased supply. Assuming aggregate demand is unchanged, a negative (or adverse) supply shock causes a product’s price to spike upward, while a positive supply shock decreases the price.
- A supply shock is an unexpected event that changes the supply of a product or commodity, resulting in a sudden change in price.
- A positive supply shock increases output, causing prices to decrease, while a negative supply shock decreases output, causing prices to increase.
- Supply shocks are caused by unforeseen events that reduce output or interrupt the supply chain, such as natural disasters or geopolitical events.
- Crude oil is a commodity that is considered vulnerable to negative supply shocks due to the political and social volatility of its Middle East source.
Understanding Supply Shock
A positive supply shock increases output, which causes prices to decrease due to a shift in the supply curve to the right, while a negative supply shock decreases production, which causes prices to rise. 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 vulnerable to negative supply shocks is crude oil, because a majority of the world’s supply comes from the volatile Middle East region. As of 2021 the Organization of the Petroleum Exporting Countries (OPEC) member nations, located in the Middle East, Africa, and South America, accounted for 80.4% of world oil reserves, with Middle East members alone accounting for 67.1% of that supply. Oil supply has also been affected by Russia’s invasion of Ukraine, sending gas prices in the U.S. skyrocketing in 2022.
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Examples of Supply Shock
The struggles of a single firm can cause a supply shock if the company is a large producer of high-demand products. According to reportage by CNBC, this was the case 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 was positive for competing firms.
According to a report in The Economist, a slowdown in Chinese demand for copper caused prices to drop. For the previous decade, demand had grown at an annual rate of more than 10% until it fell to 3% to 4% in 2015. This drop in the price of copper 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.
What Does a Supply Shock Look Like?
A supply shock occurs when an unpredictable event happens that suddenly either decreases or increases the supply of a product or commodity. The former causes a price rise, while the latter results in a price decrease.
What Kind of Events Cause Supply Shocks?
They can be anything from a natural disaster to an economic recession to a pandemic to an act of war or terrorism. Technological breakthroughs can also be a culprit, as can political acts, such as the 1973 oil embargo organized by OPEC in response to the Arab-Israeli War.
Did the COVID-19 Pandemic Cause Supply Shocks?
COVID-19 caused both supply shocks and demand shocks. For instance, because of social distancing and lockdowns, workers weren't able to be on manufacturing production lines, so there were shortages of goods. And consumers weren't going to restaurants and salons, so there was a demand shock in these and other sectors.
How Long Do Supply Shocks Last?
Supply shocks can be either temporary, such as those caused by the global financial crisis of 2009, or permanent, such as the introduction of fracking technology, which resulted in the U.S. becoming a net energy exporter in 2019, the first time this had happened since 1952. According to the World Bank in 2020, permanent shocks accounted for 47% of price variability, with temporary ones mounting up to 53%.