News.cx
BREAKING NEWS Executive orders, explained
Business

What a supply shock is and how it affects prices

A supply shock is a sudden change in the availability or production cost of goods and services that can move prices and output.

Hana Yoshida

By Hana Yoshida · Markets Reporter

3 min read

A supply shock is a sudden, unexpected change in the availability of goods or services that causes prices to adjust, according to Investopedia. It can also arise when production costs jump, reducing what firms can profitably supply, StoneX says.

With demand unchanged, a negative supply shock usually means higher prices and less output. A positive supply shock increases supply or makes production more efficient, tending to lower prices and raise output, according to the economic explanation summarized by Wikipedia.

Negative and positive supply shocks

  • Negative supply shock: Supply falls or costs rise. In the standard supply-and-demand model, the supply curve shifts left; price rises and the quantity exchanged falls when demand is unchanged.
  • Positive supply shock: Supply rises or production becomes more efficient. The supply curve shifts right; price falls and quantity rises when demand is unchanged.

The size of the price and quantity changes depends in part on demand. Wikipedia notes that when demand is less responsive to price, a negative shock has a larger effect on prices and a smaller effect on quantity.

What can cause a supply shock?

StoneX lists natural disasters, conflict, trade embargoes and restrictions, blocked shipping routes, port shutdowns, and higher energy or raw-material costs among potential causes of negative shocks. Technological advances that improve production efficiency can create a positive shock.

An oil embargo is a standard negative example. Wikipedia says an embargo can reduce oil availability, while technology that improves production efficiency is an example of a positive supply shock.

Supply shock vs. demand shock

A supply shock changes businesses' ability or cost to make, transport, or deliver goods and services. A demand shock changes buyers' desire for particular goods and services, according to Cleo.

A useful first check is to ask which side changed: producers' capacity or costs, or buyers' willingness to purchase. For a supply shock, then assess the expected direction of price and quantity with demand held constant.

Why negative shocks can raise prices while output falls

For an economy-wide negative shock, Wikipedia describes aggregate supply shifting left in the short run. That reduces output while raising the general price level, a combination associated with stagflation.

Why duration and inventories matter

A disruption may be temporary, such as a blocked shipping route, or persist through conditions such as war or a trade embargo, StoneX says. Its longer-term effects depend on whether it lasts.

Businesses can cushion a temporary shock by drawing down inventories, according to a Federal Reserve Bank of Richmond analysis. If costs stay elevated, they eventually must rebuild inventory at higher prices, which may mean passing more of the increase to customers.

Frequently asked questions

What is the difference between a supply shock and a demand shock?

A supply shock changes producers' ability or cost to make and deliver goods or services. A demand shock changes buyers' desire for particular goods or services, according to Cleo.

Why can a negative supply shock cause inflation and slower economic growth?

Wikipedia says an economy-wide negative supply shock can reduce output while increasing the general price level. That combination is associated with stagflation.

How can inventories soften a temporary supply shock?

The Federal Reserve Bank of Richmond says businesses can draw down inventories to cushion a temporary shock. If costs remain elevated, inventory must be replaced at higher prices, which may lead firms to pass on some of the increase.

Sources