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Study notes

Demand and Supply-Side Economic Shocks

  • Levels: AS, A Level
  • Exam boards: AQA, Edexcel, OCR, IB

Shocks are events that are by and large unexpected and bring out changes in real economic growth, inflation and unemployment. All countries are exposed to some degree to external economic shocks. There is evidence that lower and middle-income developing nations are more vulnerable partly because they have a less diversified economy with a narrow range of production and export industries.

External Shocks and the Economic Cycle - Revision Video

Demand-side shocks

Demand-side shocks affect one or more of the components of aggregate demand - examples of such shocks might include:

  1. Economic downturn in a major trading partner
  2. Unexpected tax increases or cuts to welfare benefits
  3. Financial crisis causing bank lending /credit to fall
  4. Bigger than expected rise in unemployment rates

A negative demand-side shock can also bring about negative multiplier effects and also a negative accelerator effect on the level of investment spending.

Supply-side shocks

Supply-side shocks affect short run aggregate supply and can also affect a country's long-run productive potential. Examples of such shocks might include:

  1. Steep rise in oil and gas prices or other commodities
  2. Political turmoil / strikes
  3. Natural disasters causing sharp fall in production
  4. Unexpected breakthroughs in production technology

A good example of a major external shock affecting many countries is a large rise or fall in the global price of energy. Consider for example the likely effects of an increase in energy prices:

Macroeconomic policy can often respond to the effects of external shocks. For example, if there is a deflationary demand-side shock, then a nation's central bank might decide to lower their main policy interest rates or use some other form of expansionary monetary policy.

The effects of external shocks depend in part on what type of exchange rate system a country has chosen to use.

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