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Supply shocks can be positive or negative, causing a shift in demand and prices. Positive shocks can result from increased supply, while negative shocks can result from decreased supply due to natural disasters, accidents, or geopolitical events. Businesses can prepare for supply shocks by purchasing insurance or staying alert for early warning signs.
A supply shock is an unexpected event that changes the availability of supply, causing a corresponding shift in demand and prices. Supply shocks can be positive, meaning increased supplies are available, or negative, meaning decreased availability. Either way, they can sometimes cause a knock-on effect in the economy if the supply in question is a key component of the economy, such as in the case of sudden changes in oil availability.
Positive supply shocks occur when something happens to increase the expected supply of something. This can commonly happen with agriculture, where unusually good weather conditions could result in a bumper crop. While this may seem beneficial to farmers, it can actually create a problem, as as the availability of a crop increases, the demand decreases. Prices will fall and the situation may get to the point where it is cheaper to plow the crops than to bring them to market. This can also happen when too many farmers decide to produce one crop in a particular year, not realizing that others have increased their planned production as well.
Negative supply shocks decrease the supply of something. Natural disasters and industrial accidents are a common cause of negative supply shocks, as they damage supplies or make it impossible to move them. Refinery fires, for example, can reduce available refined petroleum products such as gasoline. Demand will increase and prices will rise in response. Well-positioned people can take advantage of a negative supply shock to sell goods at high prices.
Geopolitical events can also contribute to positive and negative supply shocks. Everything from opening borders to setting new policies can affect the supply of certain items. When prices rise or fall dramatically, related products and commodities can also take a hit. In the oil supply shock example, for example, high oil prices drive up the costs of everything made with oil, from manufacturing to plastics.
By its nature, a supply shock is unpredictable. However, people in business try to take steps to consider possible sources of supply shocks so they can deal with them if they occur. Farmers can purchase insurance to protect against crop damage and overproduction, for example. People involved in stock and futures trading also stay alert for early warning signs indicative of a potential supply shock, keeping in mind that sometimes these signals can be very subtle.
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