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Favorable Supply Shocks & Unfavorable Supply Shocks

Favorable Supply Shocks & Unfavorable Supply Shocks
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  • 2:38 Unfavorable Supply Shocks
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Lesson Transcript
Instructor: Jon Nash

Jon has taught Economics and Finance and has an MBA in Finance

In this lesson you'll learn the definitions, causes and effects of the two types of supply shocks in the economy by looking at a fictitious economy as an example.

Unexpected Supply Curve Shifts

Let's return to the town of Ceelo, where we find Bob the business owner mowing lawns and Matt working at a local factory. What we want to know is what happens if there is an unexpected increase or decrease in supply within the economy? How does this affect Bob the business owner and Matt the factory worker, and how does it affect the growth of the economy?

Short-run aggregate supply curves show the correlation of prices and economic output
Short Run Aggregate Supply Curve

The short-run aggregate supply curve illustrates the relationship between prices and economic output. More specifically, it shows us the quantity supplied at different price levels throughout the whole economy.

Certain events cause a shock to supply and shift the short-run aggregate supply curve. A supply shock is an unexpected event that causes a sudden increase or decrease in supply and, therefore, a sudden increase or decrease in price. Some events are favorable and lead to a stronger economy, while others are unfavorable, and they lead to slower economic growth. Let's take a brief look at both types of shocks with the help of some real world examples.

Favorable Supply Shocks

A favorable supply shock is a sudden increase in supply that shifts the short-run aggregate supply curve (SRAS) to the right and results in lower prices and an increase in real GDP.

Favorable supply shocks result in:

  • Lower costs
  • Lower prices
  • Higher real output or real GDP
  • Lower unemployment

For example, an unexpected increase in the world supply of oil leads to an increase in real GDP and falling prices for gasoline in the town of Ceelo. Bob, who owns a lawn service, is very happy about this because gasoline is a cost to him. Matt is also very happy about this, and he begins to think about enjoying the savings from lower gas prices by taking his family on a road trip.

Favorable supply shocks shift the aggregate supply curve rightward
Favorable Supply Shock Graph

Causes of favorable supply shocks include:

  • Unusually great weather patterns
  • Sudden increases in the supply of raw materials
  • Development of new technology
  • Discovery of a new energy source

Unfavorable Supply Shocks

An unfavorable supply shock is a sudden decrease in supply that shifts the short-run aggregate supply curve (SRAS) to the left, so this is the opposite of a favorable supply shock.

Unfavorable supply shocks lead to:

  • Higher costs
  • Higher prices
  • Lower real output or real GDP
  • Higher unemployment

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