Economics 4

Help me in understanding sources of shock to the inflation rate

Demand shock
Supply shock

Greetings friend!

The issue they are discussing here is “why is inflation so dang high, we didn’t plan for or expect this!”

In other words, the unexpected/unplanned high inflation is a worry to the economy, and the government is trying to figure out why so that it can consider steps to address it. Price levels are increasing beyond expectations, and it’s something that a government or economist will want to investigate, to understand “why” this high inflation is happening and figure out what to do to try and fix the situation from becoming worse.

Why do prices go up? Well, as economics teaches us, it is typically due to either (1) an increase in demand for products, or (2) a low supply of products, or some combination of both (1) & (2). So the unexpected price level increases here can be attributed to either higher than expected demand for products by consumers (demand shock) or a surpisingly low supply of products (supply shock). For instance, a hot new collectable sneaker that everyone wants can see its prices skyrocket to high levels (demand shock), while the price of gasoline at the pump can skyrocket when OPEC decides to cut supply or a major pipeline has a system failure (supply shock).

With demand shock, there is normal supply for products but the crazy demand makes prices go up as consumers compete with each other to buy the products. Think hand sanitizers during the beginning of covid, when people were hoarding them and buying 10x more than they needed.

With supply shock, demand hasn’t changed much but the supply of the product has decreased. It has become more scarce. But it’s important, people still need it. So the decreased supply in combination with steady unchanged demand will cause prices to increase also.

Good luck on your exam - cheers - you got this👍

Thank you so much