A supply shock happens when something suddenly changes the cost or ability to produce goods and services. In the case of a negative supply shock, costs jump because of events like oil price spikes, crop failures, wars, shipping disruptions, or new shortages of key inputs. Businesses respond by producing less at every price, which pushes market prices higher and lowers the quantity sold.
This matters for personal finance because families may face higher prices for essentials like food, gas, electricity, and transportation.
Key Facts
- A negative supply shock shifts the supply curve left or up because producers are willing to sell less at each price.
- After a negative supply shock, equilibrium price rises and equilibrium quantity falls.
- Higher input costs reduce profit per unit unless firms raise prices or cut production.
- Equilibrium occurs where quantity supplied equals quantity demanded, so Qs = Qd.
- A supply shock can cause cost-push inflation when rising production costs lead to higher consumer prices.
- If demand is inelastic, a supply shock causes a larger price increase because buyers do not reduce quantity demanded much.
Vocabulary
- Supply shock
- A sudden event that changes production costs or the amount producers can supply.
- Negative supply shock
- A shock that makes production harder or more expensive, shifting supply left and reducing output.
- Equilibrium price
- The market price where the quantity consumers want to buy equals the quantity producers want to sell.
- Input cost
- The cost of resources used to produce a good or service, such as labor, fuel, materials, or rent.
- Cost-push inflation
- A rise in the overall price level caused by higher production costs spreading through the economy.
Common Mistakes to Avoid
- Confusing a supply shock with a demand change. A supply shock starts with production costs or availability, not with consumers suddenly wanting more or less.
- Drawing the supply curve shifting right after costs increase. Higher costs make firms supply less at each price, so the supply curve shifts left or up.
- Assuming price and quantity both rise after a negative supply shock. In the standard supply and demand model, price rises but quantity produced and sold falls.
- Ignoring elasticity when predicting price changes. If demand is inelastic, consumers keep buying despite higher prices, so the price increase is often larger.
Practice Questions
- 1 A market starts at an equilibrium price of 6 and quantity is 750 units. What is the change in price and the change in quantity?
- 2 A bakery pays 2.60 per loaf, and the bakery cuts output to 420 loaves per day. By how much did ingredient cost per loaf increase, and what is the decrease in daily output?
- 3 A hurricane damages oil refineries, causing gasoline production costs to rise. Explain how the supply curve shifts and what happens to the equilibrium price and quantity of gasoline.