A supply shock is an unforeseen event that suddenly changes the supply of a product or commodity, leading to an unexpected change in price. Supply shocks can be negative, resulting in reduced supply, or positive, leading to an increased supply. Assuming aggregate demand remains the same, a negative supply shock drives prices up, whereas a positive supply shock brings prices down.
Key Takeaways
- A supply shock is an unexpected event that alters the supply of a product or commodity, resulting in a sudden price change.
- Positive supply shocks increase output and decrease prices, while negative supply shocks reduce output and increase prices.
- Causes of supply shocks include natural disasters, geopolitical events, and other unforeseen incidents that disrupt supply chains.
- Crude oil is highly susceptible to negative supply shocks due to the volatile political and social environment of its major suppliers.
Understanding Supply Shock
Positive supply shocks increase output, causing prices to fall due to a rightward shift in the supply curve, while negative supply shocks lower production, pushing prices up. Such shocks can stem from any unexpected event that restricts output or disrupts the supply chain, ranging from natural disasters to geopolitical upheavals, including wars or acts of terrorism.
Crude oil is a prime example of a commodity vulnerable to negative supply shocks, as much of the global supply originates from the politically volatile Middle East. For instance, as of 2021, OPEC member nations from the Middle East, Africa, and South America held 80.4% of world oil reserves, with Middle East members alone accounting for 67.1%. Recent events, like Russia’s invasion of Ukraine, have also drastically impacted the oil supply, causing dramatic price increases worldwide.
Examples of Supply Shock
In September 2015, mining giant Glencore announced the closure of two major copper mines in the Democratic Republic of Congo and Zambia, removing 400,000 tonnes of copper from global circulation. This move, responding to prolonged low copper prices, significantly impacted the market, benefiting competing firms by reducing overall supply.
Conversely, a slowdown in Chinese demand for copper, declining from an annual growth rate exceeding 10% to 3%-4% in 2015, caused prices to drop. This showcases how concentrated demand changes can influence prices, qualified as shocks due to their abrupt and temporary nature, similar to supply-side shocks.
What Does a Supply Shock Look Like?
A supply shock occurs when an unpredictable event leads to a sudden decrease or increase in the supply of a product or commodity. A decrease in supply typically causes prices to rise, while an increase results in price drops.
What Kind of Events Cause Supply Shocks?
Supply shocks can result from a wide range of events, including natural disasters, economic recessions, pandemics, acts of war or terrorism, technological breakthroughs, and political actions like the 1973 OPEC oil embargo responding to the Arab-Israeli conflict.
Did the COVID-19 Pandemic Cause Supply Shocks?
Yes, the COVID-19 pandemic induced both supply and demand shocks. Social distancing and lockdowns interrupted production lines, leading to shortages, while consumer behavior shifts, such as reduced demand for restaurant and salon services, triggered demand shocks.
How Long Do Supply Shocks Last?
The duration of supply shocks varies and can be temporary, as seen during the global financial crisis of 2009, or permanent, like the introduction of fracking technology. The fracking boom transformed the U.S. into a net energy exporter in 2019, a milestone since 1952. According to the World Bank, as of 2020, permanent shocks accounted for 47% of price variability, with temporary shocks contributing 53%.
Related Terms: Demand Shock, Aggregate Demand, Supply Chain.
References
- EconPort. “Supply and Demand Shocks”.
- OPEC. “OPEC Share of World Crude Oil Reserves, 2021.”
- Northwestern University. “How the War in Ukraine May Affect U.S. Gas Prices”.
- U.S. Department of State: Office of the Historian. “Oil Embargo, 1973-1974”.
- Federal Reserve Bank of St. Louis. “Economic Research: Is the COVID-19 Pandemic a Supply or Demand Shock?”
- World Bank. “Persistence of Commodity Shocks”.
