Students / Subjects

Handbook >> Market Equilibrium >>

Supply and Demand Shocks

In the context of economic markets, anything that unpredictably affects the market in a large manner is considered a shock.

Supply Shocks

The supply of goods and services are often the ones who face shocks, though they can affect producers and consumers alike.

Negative Supply Shock

  • Causes the quantity supplied to be rapidly reduced, and the price to increase quickly until a new equilibrium is reached.
  • A good example of this would be any natural disaster or other unanticipated event that disrupts the production process and/or supply-chain. An instance of this would be Hurricane Katrina's detrimental affect upon the oil and gasoline industry: oil rigs, refinement plants, and pipelines were either shut down or taken off line.
  • A hypothetical example of this could be if a key resource input of a firm's production process was found to have a much more valuable application in another use, then the cost of the input would rise. For instance, if a pipe-fitters firm's production process used a metal that the microchip industry found a novel use for, the price of that metal would increase. Thus the amount of pipes supplied would fall and their price would increase.

Positive Supply Shock

  • These usually come in the form of overnight technological advances that quickly improve the productivity of labor and the return of capital. These improvements cause the quantity supplied to increase and the price to fall. For instance, this age of computers and robots has represented an unprecedented increase in productivity that goods can be mass produced on a massive but relatively inexpensive scale.
  • It could also occur if a new, cheaper substitute for an expensive production input is found. For instance, the discovery of a seam of low-sulfur coal out in Powder Basin, Wyoming.

Demand Shocks

Though often considered as solely an issue on the supply side, shocks can affect demand as well. Demand shocks are also commonly perceived to come about because of changes in consumer preferences, but they can also be linked to changes in other factors of demand like the price of complements and substitutes.

Negative Demand Shocks

  • These cause less quantity of goods to be consumed, and those consumers still in the market pay a lower price for the good. An example of this would be if a medical journal reported that a widely used prescription drug appreciably increases your chances of cancer. Then there would be a sharp shift in demand with less goods being consumed at a lower price.

Positive Demand Shock

  • Conversely, this type of shock can cause more goods to be consumed at a higher price. Consider the combined effects of two simultaneous events upon the demand of two complements, fish and tartar sauce: a new nutritional study conclusively touts the many health benefits of eating fish, and there are commercial fishing efficiency advances that make fish inexpensive. More people will want to eat fish, leading them to buy more tartar sauce even though it's now at a higher price.

Back to Equilibrium

Copyright 2006 Experimental Economics Center. All rights reserved. Send us feedback