What is a supply shock? 2 important types of supply shocks

You have probably noticed that the prices of goods and services are susceptible to various political and economic events and faithfully reflect the current state of the economy. When unexpected events and deviations from the norm take place in the world in the form of crises, certain political decisions, conflicts or breakthroughs, we may experience the so-called supply shock. If you haven’t come across this concept before, read the following article.

What is a supply shock? – table of contents:

1. What is a supply shock?
2. Types of supply shocks
3. Examples of a supply shock
4. How to prevent supply shocks?
5. Summary

What is a supply shock?

As the very name suggests, a supply shock happens when there is a sudden change in the supply of goods and services, resulting in price fluctuations. The causes of this phenomenon are usually unexpected events that disrupt the economic stability of the country.

Types of supply shocks

Depending on what led to a supply shock, we can make a distinction between positive and negative supply shocks.

A positive supply shock

We can speak of a positive supply shock if, as a result of a given event, there is an increased production of goods, which improves their availability on the market. The factors that cause it are, for example:

• a decline in commodity prices e.g. copper or oil ( due to their use in industry, this lowers the production costs and, at the same time, boosts production),
• technological development – improves the efficiency of production, optimizing costs, as well as increasing corporate profits and supply,
• grants, additional funds for business growth,
• reducing tax liabilities,
• a higher currency exchange rate.

A negative supply shock

The opposite phenomenon to the above is a negative supply shock, which leads to a halt in production and an increase in commodity prices. What are the causes of a negative supply shock?

• an increase in commodity prices,
• armed conflicts, which can have an impact, for example, on the supply of commodities (gas, food),
• natural disasters, epidemics, e.g. the Covid-19 pandemic (temporary suspension of business activities, restrictions on mobility),
• higher unemployment rates and lower wages, which leads to reduced household consumption (people are reluctant to spend money as they worry about the future and lack savings),
• high customs duties for transporting goods, banning imports and exports to certain countries.

Examples of a supply shock

Glencore

Glencore, a Swiss multinational commodity trading and mining company, decided to close its mines in Africa in 2015. Declining copper prices on the market were the main reason for this decision. This resulted in a significant reduction of its copper extraction, which turned out to be a positive supply shock for competitors.

Food prices

The current mechanisms and consequences of a supply shock have become commonplace not only in Poland, but also in other corners of the world. Due to the Covid-19 pandemic and the Russia-Ukraine international armed conflict, prices get higher from week to week. According to the Retail Prices Index (RPI), the fastest growing products are oil, dry goods (e.g. the information about an increase in sugar prices reverberated in the media and caused a rush of panic among the public), dairy products and meat.

Unfavorable weather conditions in Brazil, the largest exporter of the commodity, which have negatively affected the cultivation of sugarcane, are given as one of the main reasons for the increase in sugar prices. In turn, at the beginning of 2023, the General Veterinary Inspectorate in Poland, reported more than a dozen cases of bird flu, which caused great losses and a 16% increase in prices.

Computers and the Internet

The popularization of the Internet and computers in the United States in the 90’s was a real revolution. This is an example of a positive supply shock as these inventions increased the productivity and profits of enterprises. Between 1995 and 1999, there was a decline in inflation, almost a double increase in GDP and a double decrease in the unemployment rate.

How to prevent supply shocks?

In the light of previous experience, entrepreneurs need to pay more attention to crisis management strategies to protect themselves from the consequences of supply shocks. What measures should you take?

1. Invest in a modern IT infrastructure to manage your supply chain more effectively.
2. Expand your supplier base so that in case of unexpected events, you have an extensive network of contacts and do not expose your business to downtime.
3. Reduce inventory levels to a minimum – unused resources can quickly start to bring financial losses. You can use one of the lean management tools for this – the Just in Time method.
4. If possible – instead of being dependent on foreign suppliers, look for business partners in your local area. You will have an alternative solution in case of international mobility restrictions.

Summary

The events we are currently witnessing don’t fill us with optimism, and making the right decisions in these uncertain times is a great challenge. Therefore, if possible, run your business in such a way that in case of crisis situations, you will always come out unscathed.

Read also: What is a strategic analysis?

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