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What Is Demand Shock?

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  • Written By: Jan Fletcher
  • Edited By: Jessica Seminara
  • Last Modified Date: 21 November 2016
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Demand shock is an economic term that refers to sudden changes in the level of demand for a particular product or property purchase. These events may arise from a number of factors. They might include a mismatch between the level of public desire for an item versus available supply, changes in tax laws, and available financing if the costs of goods exceed the capacity of most people to buy the item with cash. Another potential trigger of demand shock may be media coverage that stimulates a desire in the public for an item.

The term "level of demand" describes the correlation between available product and the numbers of consumers who want the product, have the capacity to purchase it, and intend to buy it soon. All three factors are typically involved in triggering a demand shock. For example, millions of people may want to purchase a new technological gadget, and may also possess the capacity to buy the item. If most wait to buy it at a particular season, such as a major holiday, a demand shock will likely occur. Without the added factor of a gift-giving season, demand likely would be spread out more evenly over a period of time.

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Factors that trigger a demand shock vary widely and are not always predictable, as in the case of a fad. For example, if a popular new toy captures the attention of consumers and the desire to own the product becomes intense, the demand for the product will rise sharply, producing a sudden upward swing in the demand curve. When demand is plotted against supply on a two-dimensional graph, it produces a line which can be straight or curved, which is the origin of the term "demand curve."

A major cause of a demand curve is when planned production of an item does not match public demand over a specific period of time. Too little production of an item may result in a positive demand shock, while overproduction may result in a negative demand shock. Both present difficulties for manufacturers. The first case usually results in missed opportunities to sell a product when consumer desires are strong. In the second circumstance,manufacturers must pay more than anticipated to store or liquidate unsold inventory.

Changes in tax laws may be used to manipulate production levels, particularly if a negative demand shock occurs. For example, if too many houses are erected in a speculative real estate frenzy, such as occurred during the U.S. subprime mortgage crisis in the mid- to late 2000s, legislators may pass laws granting tax incentives to correct the imbalance. Luxury items may be taxed at higher rates during prosperous times, as increasing taxes during those times typically will not negatively impact sales. Media coverage may also have powerful impact on demand shocks, since consumers receive feedback from media stories and often incorporate that information into purchasing decisions.

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Terrificli
Post 2

@Vinzenzo -- I'm not sure I agree. If the economy is in the tank, citizens want action and the federal government may be the only entity large enough to make a positive impact. If the government takes an action that only boosts demand temporarily, then at least those actions may have kept things from getting any worse.

Even a minor improvement in demand may well be worth the money the government spends.

Vincenzo
Post 1

There is a major problem with the government getting involved to correct negative demand shock. Take the tax incentives mentioned in the article, for example. Those created demand for a short period of time, but they only delayed the inevitable. As soon as the tax credits went away, sales dropped to around the same level they were before Congress took action.

We've seen that happen time and time again. When the government starts using tax credits and such to take care of a situation, the drop in demand will either be merely delayed or will get worse once the government help is gone.

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