Blog
Revision: Demand-side shocks
4th May 2009
One of the really interesting things about being a macro economist is that lots of unexpected events can happen which cause changes in the level of demand, output and employment. The headwinds can alter direction with great speed leading to uncertainty about where the economy is heading. These unplanned events are called “shocks” and many of them happen in other countries or parts of the global economy but they have an effect across many different countries. We have certainly had more than our usual share of them in recent years! Students need to understand the possible causes of shocks but also to be able to trace and discuss their broader impact on specific industries and the economy as a whole.
One of the causes of fluctuations in the level of macroeconomic activity is the presence of demand-side shocks.
Some of the main causes of demand-side shocks are as follows:
o A capital investment boom e.g. a construction boom to increase the supply of new houses or to build new commercial and industrial buildings.
o A big rise or fall in the exchange rate – affecting net export demand and having follow-on effects on output, employment, incomes and profits of businesses linked to export industries. Sterling has depreciated by more than 25% over the last year - what possible effects will a sustained fall in sterling have on the UK economy and out trade partners?
o A contraction in consumer demand abroad in the country of one of our major trading partners which affects the demand for our exports of goods and services.
o A large slump in the housing market or a slump in share prices. Asset price deflation can have a huge impact on confidence and sentiment.
o An event such as the global credit crunch – involving a sharp fall in the amount of credit available for borrowing by households and businesses.
o An unexpected cut or an unexpected rise in interest rates or change in government taxation.
These shocks will bring about shifts in the aggregate demand curve and have direct and indirect effects on key indicators such as
(i) Inflation
(ii) Output
(iii) Business profits and investment
(iv) Government tax revenues, spending and borrowing
(v) Employment
A full set of AS macro revision notes is available here and our AS economics revision presentations can be found here
Geoff Riley
Geoff Riley FRSA has been teaching Economics for over thirty years. He has over twenty years experience as Head of Economics at leading schools. He writes extensively and is a contributor and presenter on CPD conferences in the UK and overseas.