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Dictionary of Economics

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Real Shocks

What are real shocks?

A real shock to an economy is an unexpected or unpredictable event that affects the fundamental factors of production. It can have a positive or a negative effect. Examples of real shocks include droughts, changes to the oil supply, hurricanes, wars, and technological changes.

Real shocks are not limited to one sector of an economy; they may be amplified and transmitted to other areas. Big enough real shocks can result in economy-wide recessions – or even a depression.

Want to dive deeper into these topics? Check out our Macroeconomics section on Business Fluctuations where we cover real shocks in more detail.

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Transcript

What are real shocks? Droughts, changes to the oil supply, hurricanes, wars, and technological changes are all examples of both positive and negative real shocks that can have big and potentially far-reaching consequences on the economy. Let's take a look at the U.S. economy.

 

The U.S. economy grows at about 3 percent per year on average. But it does tend to fluctuate quite a bit. If you've ever wondered why that is, well, one cause is real shocks, which can affect the fundamental factors of production. For instance, the supply of oil might leap up, or leap down. The weather can be an important positive or negative shock as well, especially in agricultural economies. We call shocks like this real shocks because they directly affect how the factors of production are transformed into output.

 

Even in developed economies, a bad hurricane, like Hurricane Sandy -- that can slow growth for a quarter or two. It's hard to run a factory, for example, when the factory has been flooded. Even factories far from the center of the hurricane -- they may have to slow down if they can't get parts, for example. Wars, or big changes in taxes or regulations, or other government policies, can also shock the economy as can changes in ideas or technology. Real shocks in one area of the economy can also be amplified and transmitted to other areas of the economy. A shock to the banking sector, for example, can be amplified and transmitted to other sectors. And if the shocks are big enough -- yes, recessions, and even depression, can be the result.

 

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