Shock (economics)

In economics, a shock is an unexpected or unpredictable event that affects an economy, either positively or negatively. Technically, it refers to an unpredictable change in exogenous factors — that is, factors unexplained by economics — which may influence endogenous economic variables.

The response of economic variables, like output and employment, at the time of the shock and at subsequent times, is measured by an impulse response function.^[1]

Types of shocks

If the shock is due to constrained supply, it is called a supply shock and usually results in price increases for a particular product. A technology shock is the kind resulting from a technological development that affects productivity. Inflationary shock happens when prices of commodities increase abruptly (e.g. following government subsidies cut) while not all salaries are adjusted immediately throughout society (this leads to a temporary loss of purchasing power for many consumers); or that production costs fall behind corporate revenues for the same set of reasons (e.g. following energy price hikes).

Shocks can also be produced when accidents or disasters occur. The 2008 Western Australian gas crisis resulting from a pipeline explosion at Varanus Island is one example.

In the context of microeconomics, shocks are also studied at the household level such as health, income, and consumption shocks. For example, in development microeconomics the relationship between household income shocks and household levels of consumption are studied to understand a household's ability to insure itself (testing the full-insurance hypothesis).

See also

• Vector autoregression
• Dynamic stochastic general equilibrium
• Exogenous
• Supply shock
• Demand shock
• 1973 oil crisis
• Shock therapy
• Social risk management

References