Supply shock can be positive where there is an increased supply or negative when supply is decreased. Its effects can be either long term or short term depending on the nature of the cause.
Supply shock are be categorized into two groups which are adverse supply shock and beneficial supply shock. In summary, adverse supply shocks decreases supply while beneficial supply shock increases …show more content…
This brings about unpredicted increase in costs and division to production. An adverse supply shock could lead to sudden scarcity or excess demand. Its recovery depends generally on how fast and well the economy or markets adjust itself, which could lead to increase in prices and decrease in quantity traded.
Adverse supply shocks can either be natural events (such as natural disasters) or man-made events (such as war). Natural events such as droughts or floods could affect agriculture production which in turn could cause adverse supply shock for certain products. This shortage reduces the amount of that particular agricultural product in the market, which raises the price (assuming demand remains constant).
Examples of adverse supply shock include natural calamities like extreme weather occurrences. When drought happens, corps die easily since the environment is not suitable for them to grow and survive. This dwindles the production and supply of crops. The lower supply can cause an increase in prices since there is a less supply than demand …show more content…
This causes the equilibrium point of the two aggregate supply and aggregate demand to change too.
This causes a higher price level of goods and services and lowers real GDP. Price level rises from P1 to P2 and real GDP decreases from Y1 to Y2. Since there is a smaller supply in the market than the demand, the price will increase. A shortage of supply causes real GDP to lower since production decreases due to lack of raw materials.
An example of beneficial supply shock is an appearance of a cheaper substitute in manufacturing a product. Since it is cheaper to manufacture the product, a larger quantity will be produced than normal to maximize profit.
Besides that, technological advancement can also increase supply in the market. Efficiency is increased and more products can be made from the same amount of raw materials, thus increasing the supply. A new invention, for instance, can cause the cost of producing a product to go down, thus increasing supply and lowering the price of the good.
A decrease in barrier of entry can increase supply. It is easier for new companies to enter the market, creating more supply in the