Positive Demand Shock

We think of shocks as bad things. Electrocutions, earthquakes...serial killers in our basement.

So...what’s a positive shock?

Think about Frankenstein’s monster. The monster is dead flesh all sewn together. Then he’s struck by lightning. Suddenly, he’s up and stumbling around.

He’s AAAALLLIIIIIIVVVVEEE!

Good for Frankie Mo. He gets to be alive...that's a positive. For him, at least. But it's still disruptive. Now we’ve got a seven-foot tall green guy bumbling around, knocking stuff over, scaring villagers, and possibly throwing kids into lakes.
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A positive demand shock in economics works in a similar way. The shock is that aggregate demand suddenly spikes. Usually, it means something happened to put a lot more money into a market than was there before. On the small scale, the demand shock can be positive.

Like...if you're are a company selling a product that suddenly sees a spike in demand shock...it’s a good problem to have. It’s good for business that people want your stuff.

Just to get the concept down, let’s focus on the small scale for a second. Positive demand shock on the individual or corporate level. Think: bottled water when a hurricane is coming. Or that new brand of sunglasses after a Kardashian wears them in an Instagram post. Or earplugs when the Shmoop Singers come to town.

These things boost demand suddenly. Enough to skew the market. There can be negative shocks as well. This is where demand suddenly plummets. You’ve got a popular vitamin; people buy them by the caseload. But now a report comes out showing that taking the vitamin every day for a period of time will cause a person to grow scales.

Ugh. Sales plummet. Negative demand shock.

There are two basic ways a market can react to these shocks. Remember your basic economic training: everything is supply and demand. Prices are a way to keep these forces in balance. If demand suddenly skyrockets...at least one of two things are going to happen. Maybe both will happen.

One: prices are going to skyrocket.

Or two: supplies are going to quickly run out.

Those are shocks on a corporate level. Relatively small scale. There are also shocks at the level of the whole economy. Shocks involving aggregate demand.

It's Christmastime. The economy has been sluggish. So Congress decides to do something about it. They issue a stimulus bill. Everyone in the U.S. gets a check for $1,000 from the government. A sudden spike in aggregate demand. Now there are a couple hundred billion more dollars to be spent on Christmas presents.

The hot toy this year is the Farty Artie doll. As of October, it's retail price was $25. Stores have plenty of them in stock. Supply and demand in balance. Now the government stimulus hits. Aggregate demand spikes. Prices for everything rise suddenly. Lots more cash floating around, chasing the same goods. Just because the government sent everyone a check doesn't mean the toy company can make any more Farty Arties.

Inventories run out. A secondary market opens up with sky-high prices. Once $25, Farty Artie is going for $500 on eBay, if you want to get it under the tree by Christmas Eve.

That's a positive aggregate demand shock, like Frankenstein's monster, causing havoc wherever he goes. But don’t worry. The monster doesn’t last long. The aggregate demand shock, positive or negative, can cause short-term havoc. But in the long term, the market works itself out.

In the case of a positive aggregate demand shock, over time, companies find a way to produce more of the item to meet the new level of demand. Or prices will just have to stay higher, so that aggregate supply and aggregate demand stay balanced.

Either way, the market eventually reaches equilibrium again. Conditions adjust and, in the long-term, everything gets back to normal. Well, as normal as they can be with a 7-foot-tall monster on the loose.