Demand shock

In economics, a demand shock is a sudden event that increases or decreases demand for goods or services temporarily.

A positive demand shock increases demand and a negative demand shock decreases demand. Prices of goods and services are affected in both cases. When demand for a good or service increases, its price typically increases because of a shift in the demand curve to the right. When demand decreases, its price typically decreases because of a shift in the demand curve to the left. Demand shocks can originate from changes in things such as tax rates, money supply, and government spending. For example, taxpayers owe the government less money after a tax cut, thereby freeing up more money available for personal spending. When the taxpayers use the money to purchase goods and services, their prices go up.^[1]

In the midst of a poor economic situation in the United Kingdom in November 2002, the Bank of England's deputy governor, Mervyn King, warned that the domestic economy was sufficiently imbalanced that it ran the risk of causing a "large negative demand shock" in the near future. At the London School of Economics, he elaborated by saying, "Beneath the surface of overall stability in the UK economy lies a remarkable imbalance between a buoyant consumer and housing sector, on the one hand, and weak external demand on the other."^[2]

During the global financial crisis of 2008, a negative demand shock in the United States economy was caused by several factors that included falling house prices, the subprime mortgage crisis, and lost household wealth, which led to a drop in consumer spending. To counter this negative demand shock, the Federal Reserve System lowered interest rates.^[3] Before the crisis occurred, the world's economy experienced a positive global supply shock. Immediately afterward, however, a positive global demand shock led to global overheating and rising inflationary pressures.^[4]

See also

• Shock (economics)
• Supply shock

References

1. "Demand Shock". Investopedia. Retrieved 2008-11-02.
2. "UK could be in for demand shock". Television New Zealand. 2002-11-20. Retrieved 2008-11-02.
3. Palley, Thomas (2008-06-11). "Bernanke Fed getting it right". Asia Times. Retrieved 2008-11-02.
4. Roubini, Nouriel (2008-06-14). "The spectre of global stagflation". Daily Times. Retrieved 2008-11-02.