What is Supply-Shock Inflation?

Commonly known as cost-push inflation, the basic concept of supply-shock inflation has to do with a considerable increase in the cost of goods and services that are considered to be essential and somewhat difficult to substitute. This is different from the concept of demand-pull inflation, where consumer demand would drive the rate of inflation. Often, supply-shock inflation involves a trickle down effect that will cause changes in many sectors of the marketplace. One of the best examples of this situation is the oil crisis in the early 1970’s, which led to the rise of gas prices in North America and other sections of the world.

Generally, supply-shock inflation triggers not only the increase in the price of the core product, but also other products that are closely associated. As in the case of the rise in the price of oil, the auto industry was effected by the inflation within the oil industry. This meant that the prices for automobiles began to increase. In addition, the cost for auto parts began to creep up, which in turn made it necessary for mechanics to charge more for their services in order to cover the increased cost of securing material to repair vehicles.

Not all economists subscribe to the idea that supply-shock inflation will automatically lead to higher prices for goods in a number of markets. While acknowledging the real impact of a rise in the price of an essential product on directly related products, some financial experts believe that the phenomenon that is identified as supply-shock inflation will be offset by changes in the purchase habits of some consumers.

As an example, rising costs in gasoline has led some consumers to use public transportation or utilize bicycles instead of automobiles for short errands or as a means of getting to and from work. This type of behavior modification helps to contain the level of inflation that occurs, rather than allowing the trend to continue unhampered.

Proponents of supply-shock inflation tend to be identified as supporters of the Keynesian school of economics. In relation to this type of inflation, Keynesians understand a modern economy as including prices that are classified as sticky downward or downward inflexible. In order to prevent or at least control a tendency to a recession, supply-shock inflation may function as one way of limiting the rate of unemployment and keeping the gross domestic product from falling. From this perspective, this phenomenon may be a tool to reverse adverse economic trends, and restore at least some sense of balance to the economy of a country.