By: Lexi Prochniak and Julia Jane Duggan
Supply shocks occur when there is a shift in the short-run aggregate supply curve. This could be due to a change in commodity prices, productivity, or nominal wages. There are both positive and negative supply shocks. A positive supply shock increases aggregate output and decreases aggregate price level, while a negative supply shock decreases aggregate output and increases aggregate price level. Therefore, with a positive supply shock, the graph shifts rightward and with a negative supply shock, the graph shifts leftward. While supply shocks are less common than demand shocks, their consequences are far more severe.
The economy has a harder time dealing with supply shocks than demand shocks, which is why the time periods following supply shocks, especially negative supply shocks, are much harsher than demand shocks. For instance, since World War II, there have been twelve recessions in the United States. Eight of these recessions were the result of a demand shock, which causes the aggregate price level and aggregate output to move in the same direction. The remaining four recessions were caused by supply shocks, and resulted in the lowest unemployment rates since World War II. Additionally, in each supply shock case, there was political turmoil occurring somewhere in the Middle East. The Arab-Israeli War in 1973 and the Iranian Revolution of 1979 were two events that both were factors of the supply shocks, as world oil prices were disrupted and thus greatly increased. The Great Recession of 2008 was also a product of a supply shock, and caused extremely
low rates of unemployment.
This graph clearly shows the jump in oil prices during 2008. This negative supply shock caused production costs to increase, thus causing the price of oil to greatly increase as well.
Thus, despite the fact that supply shocks do not occur often, they are nonetheless ruthless in their outcomes.