Have you ever been shocked by something? Maybe a nearby thunderstorm dropped a bolt of lightning near your house and it startled you. Perhaps you got some really good news from a friend and you were suddenly very happy! Or maybe you got a huge, unexpected raise from your employer and you were, well, shocked! These events are all unexpected and happen suddenly. In a similar way, unexpected and sudden things can happen that shock the economy. It can happen to both supply and demand, and the shocks can be positive or negative. If you would like to know more about supply shocks, then let’s dive in!
Supply Shock Definition Economics
What is the supply shock definition in economics? A supply shock in economics is defined as an unexpected rapid change in the aggregate supply of the economy at any given aggregate price level. A supply shock can be positive or negative. A positive supply shock is represented by a rightward shift of the short-run aggregate supply (SRAS) curve, while a negative supply shock is represented by a leftward shift of the SRAS curve. In economic terms, these shifts happen relatively quickly and take the economy by surprise.
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Causes of Supply Shocks
There are many causes of supply shocks. Let’s take a look.
Input Prices
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Changes in input prices are a major cause of supply shocks. Because producers decide what and how much to produce based on profits, anything that impacts their unit production costs can shift supply one way or the other. If there is an increase in labor costs, which are a large portion of production costs, producers’ unit production costs will rise, thereby reducing their profits. Thus, they will produce less at any given aggregate price level, which will shift the SRAS curve to the left (from SRAS1 to SRAS2) and increase the aggregate price level (from PL1 to PL2), as in Figure 1 below.
Fig. 1 – Negative Supply Shock
If equipment prices decline, that would reduce production costs and increase profits, which would lead producers to supply more at any given aggregate price level. This would shift the SRAS curve to the right (from SRAS1 to SRAS2) and decrease the aggregate price level (from PL1 to PL2), as in Figure 2 below.
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Fig. 2 – Positive Supply Shock
There are also imported resources to consider. Since crude oil is an input for a large part of the economy, any change in crude oil prices can have economy-wide effects. Let’s say a war breaks out in an oil-producing region of the world. Fear that the region will produce less oil will cause an increase in the price of crude oil. In turn, any country that imports crude oil will pay a higher price, and so will the producers who use crude oil as an input within that country. As the costs of production rise, profits will fall and producers will supply less, shifting the SRAS curve to the left.
Productivity
Changes in productivity can also cause a supply shock. Productivity is defined as output per hour worked. When productivity increases, that means there are more units of output over which to spread out production costs, so unit production costs decline. This leads to an increase in profits, which spurs producers to produce more at any given aggregate price level, and the SRAS curve shifts to the right. Anything that reduces productivity, like aging equipment, would shift the SRAS curve to the left.
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