What is a Supply Shock?

A supply shock is an unexpected event that changes supply availability, causing a corresponding shift in demand and pricing. Supply shocks can be positive, meaning an increase of supplies is available, or negative, with a decrease in availability. In both cases, they can sometimes cause a ripple effect in the economy if the supply in question is a key component of the economy, as in the case of sudden changes in the availability of oil.

Positive supply shocks happen when something occurs to increase the expected supply of something. This can commonly occur with agriculture, where unusually good weather might result in a bumper crop. While this might sound beneficial for farmers, it can actually create a problem, because as the availability of a crop increases, demand drops. Prices will fall, and the situation may reach the point where it is more cost effective to plow the crops under than to bring them to market. This can also happen when too many farmers decide to produce a crop in a given year, not realizing that others have increased their planned output as well.

Negative supply shocks decrease the supply of something. Natural disasters and industrial accidents are a common cause for negative supply shock, as they damage supplies or make it impossible to move them. Refinery fires, for example, may decrease available refined oil products like gasoline. Demand will rise, and prices will increase in response. People who are positioned well can take advantage of a negative supply shock to sell goods off at high prices.

Geopolitical events can also be contributors to both positive and negative supply shocks. Anything from opening borders to setting new policies may affect the supply of certain items. When prices rise or fall dramatically, connected products and commodities can also take a hit. In the example of oil supply shock, for instance, high oil prices drive up the costs of everything produced with oil, from produce to plastics.

By its nature, a supply shock is unpredictable. However, people in business do attempt to take steps to consider possible sources of supply shock so they can address them if they occur. Farmers may buy insurance to protect themselves from crop damages as well as overproduction, for example. People involved in stock and futures trading also remain alert to early warning signs indicative of potential supply shock, keeping in mind that these signs can sometimes be very subtle.