Supply Shock

What Is a Supply Shock?

A supply shock is an unexpected event that suddenly changes the supply of a product or commodity, resulting in an unforeseen change in price. Supply shocks can be negative, resulting in a decreased supply, or positive, yielding an increased supply; however, they're often negative. Assuming aggregate demand is unchanged, a negative (or adverse) supply shock causes a product's price to spike upward, while a positive supply shock decreases the price.

Understanding Supply Shock

A positive supply shock increases output causing prices to decrease due to a shift in the supply curve to the right, while a negative supply shock decreases production causing prices to rise. Supply shocks can be created by any unexpected event that constrains output or disrupts the supply chain, including natural disasters and geopolitical developments such as acts of war or terrorism. A commodity that is widely perceived as the most vulnerable to negative supply shocks is crude oil because most of the world's supply comes from the volatile Middle East region.

Example of Supply Shock

The struggles of a single firm can cause a supply shock if the company is a large producer of high demand products such as copper. According to CNBC, this was the case when Glencore announced in September 2015 its plans to close two major copper mines in the Democratic Republic of Congo and Zambia, removing 400,000 tonnes of copper from the global output. The decision came in response to a prolonged slump in copper prices. Therefore, this particular supply shock was positive for competing firms.

According to The Economist, a slowdown in Chinese demand for copper caused copper prices to drop. For the previous decade, demand had grown at an annual rate of more than 10% until it fell to 3% to 4% in 2015. This drop in price highlights how a concentrated change in demand can influence prices. A change in demand must be abrupt and perceived as temporary to qualify as a shock, as is the case on the supply side.