An economic shock is any unexpected event that has a drastic effect on an economic system. Typically, the term "economic shock" specifically refers to events that occur outside of a given economic system but still have a significant effect on the system. In some cases, however, the term is applied to significant but unexpected events that occur within the system. Shocks tend to come either in the form of supply shocks or demand shocks; supply shocks are much more common. In an economic system, "supply" and "demand" refer to the availability and desire for a particular good or family of goods on the market.
In a supply economic shock, some unexpected event has a drastic effect on the supply of a given product or service. If the supply of a given good or service decreases significantly, its cost tends to increase and its availability tends to decrease. This combination of economic stagnation and inflation is commonly referred to as stagflation. A positive supply shock, on the other hand, usually leads to an increase in availability and a decrease in price. When this occurs, it is not uncommon for supply to exceed demand, resulting in an unsellable surplus of goods.
In a demand economic shock, on the other hand, an unexpected event suddenly and significantly alters the demand for a given good or service. The effects that this has on the economy are similar to the effects of a supply economic shock. When demand increases significantly, prices increase and availability tends to decrease; when demand decreases, price decreases and availability remains high. Sudden, drastic increases and decreases in supply or demand are referred to as positive and negative supply or demand shocks, respectively. Supply and demand shocks are both temporary in nature; eventually, the economy does return to some form of equilibrium.
An economic shock can be caused by many different events, some caused by human activity and some simply caused by chance. Natural disasters can cause economic shocks by destroying inventories of goods, destroying various means of production, or causing a sudden demand for various construction or medical supplies. The introduction of new technology can also lead to an economic shock as new technology can, in some cases, drastically increase the supply of a given product. Demand shocks usually originate from government activity; tax increases or decreases or changes in monetary or fiscal policy can lead to unanticipated changes in consumer demand.
