 ### 5.3 Supply and demand shocks

Using the above figure, the effects of demand and supply shocks on quantity and price can be analyzed.
By operating the "shock controllers", the demand- and supply- curve can be shifted parallel to the original situation. This represents a shock, i.e. a change in demand or supply. The new point of intersection, which arises after the shock occurred, indicates the new market equilibrium. This is the quantity $Q2$ and the price $P2$ at which, after the shock, consumers and suppliers see their respective interests fulfilled. As can be seen from the above figure, these points can differ significantly from the situation of the original equilibrium (marked brightly with $Q1$ and $P1$ ), depending on their type, direction and combination.
A distinction is made between demand- and supply- shocks.
In the case of a demand shock, the demand curve shifts parallelly upwards (right) if the shock is expansive and downwards (left) if it is restrictive. An expansive/positive shock means a rise of demand (e.g. due to increased income). A restrictive/negative shock means a reduction in demand (e.g., due to higher taxes).
A supply shock shifts the supply curve parallelly to the right (expansive shock) or to the left (restrictive shock). An expansive/positive shock means an increase in supply (for example, due to lower raw material costs). A restrictive/negative shock means a reduction in supply (e.g., due to higher taxes).
A vertical shift of the curves represents a reaction of the offered/demanded price for a given quantity. A horizontal shift represents a reaction of the demanded/offered quantity at a given price. For linear functions, this cannot be distinguished graphically. An exact differentiation goes beyond the scope of the contents presented here.
For the actual application, a distinction has to be made between the shifting of the curve and the moving along the curve. For example, if a shock affects the demand curve (e.g. "Demand is decreasing because income is falling"), the whole curve shifts. Reduced demand also implies a decrease of the supply to the new equilibrium. There is a movement along the supply curve, no shift of the curve itself.

(c) by Christian Bauer
Prof. Dr. Christian Bauer
Chair of monetary economics
Trier University
D-54296 Trier
Tel.: +49 (0)651/201-2743
E-mail: Bauer@uni-trier.de
URL: https://www.cbauer.de