Supply and Demand Shocks
A drought or a production-cut deal can send prices swinging. See how prices change when the supply and demand curves shift.
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Text version · Physical Commodities, lesson 2: “Supply and Demand Shocks”
A drought or a production-cut deal can send prices swinging. See how prices change when the supply and demand curves shift.
The crossing point is the price
The price is set where supply and demand cross. Less supply (output cuts, drought, war) → prices rise; less demand (recession) → prices fall.
Hard to boost output short term: small shocks, big swings
Oil wells, mines and farmland can't ramp up on demand, so the short-run supply curve is steep: even a small shortfall takes a big price rise to balance.
The cure for high prices is high prices
Once prices rise high enough, producers drill new wells and plant more, and users cut back or find substitutes. Months or years later, supply and demand rebalance and prices often fall back. Steep in the short run, gentle in the long run: that's the rhythm of supply and demand.
Key takeaways
- Commodity prices are set by supply and demand, and supply is hard to adjust in the short run.
- Less supply (output cuts, weather, war) → higher prices; weaker demand (a slowing economy) → lower prices.
- Short-run supply and demand are inelastic, so even a small shock can cause a big swing.
- Over time, high prices encourage more production and less consumption, so prices tend to come back down: "the cure for high prices is high prices".
Try it yourself
You can do these exercises in this lesson's interactive simulation:
- Click “Oil producers cut output”: what does the equilibrium price change to from $90? What % rise does the “Price change” card show?
- Click “Global recession”: industrial demand falls, so how do prices of commodities like copper and crude change?
- Drag supply to “Cut 10”, then drag supply elasticity from “Steep” to “Flat”, and compare how much the two bars below rise.
- Set supply to “Cut 10” and demand to “Buy 10 more” at the same time: is the price change bigger or smaller than the cut alone?
Quiz and explanations
- 1. Major oil producers announce output cuts. In the short run, oil prices most likely…
- Answer: Rise.Less supply, higher prices.
- 2. In a global recession, copper prices usually…
- Answer: Fall.Industrial demand drops and prices weaken.
- 3. One year, a drought in a major growing region cuts the wheat harvest, while a global recession lowers demand. Wheat prices will…
- Answer: Move in an uncertain direction, depending on which force is stronger.Lower supply pushes prices up and lower demand pushes them down. With both at work, the net effect depends on which is stronger.
Terms in this lesson
- supply and demand (Supply & Demand): The balance between people who want to buy (demand) and people who want to sell (supply), which decides where the price goes.