 Hello and welcome to the session. This is Professor Farhad in which we would look at demand and supply shocks. Usually those topics are covered in macroeconomics. In this session, I will cover them from an essential of investments perspective. As always, I would like to remind you to connect with me on LinkedIn if you haven't done so. YouTube is where you would need to subscribe. I have 1900 plus accounting, auditing, tax, finance, as well as Excel tutorials. If you like my lectures, please like them and share them. That's very important. If they benefit you, it means they might benefit other people. On my website, farhadlectures.com, you will find additional resources to complement and supplement your accounting courses, CPA, CFA, CMA, or finance accounting courses. Let's first take a look at demand shocks. What is a demand shock? A demand shock is an event that affect the demand for goods and services in the economy. Let's look at some examples. One example could be a reduction in tax rate. What happened if the government lowered the tax rate? Businesses and individuals will keep more money. Technically, they're giving you, in a sense, they're giving you an immediate refund. Also, an increase in the money supply of the Federal Reserve, and this is what's happening now. The Federal Reserve is printing more money. That's trying to create a demand shock. Increase in foreign export. The most classic example of this is the economy post World War II, where we were the only producer and were exporting to the whole world. Therefore, we had a demand shocks for expert. A big increase in government spending will tend to stimulate, generally speaking, the economy and eventually increase GDP. This is what creates demand. Stimulus payments, like the coronavirus, what's going on right now? This is a demand shock. But that's what could happen. What comes with the demand shock is could, might increase interest rate by increasing the demand for borrowed funds by the government because the government is spending. They need to borrow money as well as businesses that might desire to borrow to finance new venture because there's new demand. They want to take advantage of the new demand. They need to borrow money. The government need to borrow money to stimulate the economy. There's a demand on the money interest rate might go up. This is not what's happening in actuality. It could also, as a result, it could increase the inflation rate if the demand for goods and services is raised. If you gave every older people money, what's happening now? Now, that amount of money is chased a limited amount of supplies. Eventually, when you don't have enough supply, prices will go up, which in turn, inflation will go up. So once the demand is raised to a level or beyond of total productive capacity of the economy where we don't have any more capacity to produce, prices will go up, inflation will go up. So simply put, demand shocks bring, generally speaking, interest rate up as well as inflation. It works in tandem with those two. Supply shocks, what are they? It's an event that influenced the production capacity and basically the cost of production. They're really characterized as aggregate output that's moving in the opposite direction of inflation and interest rate versus the demand. They go hand in hand in the same direction, supply shocks in the opposite direction. Let's see how, for example, if we're looking at changes in energy prices. And this happened in 2007-2008 right before the housing crisis. A big increase in the price of imported oil is inflationary because the cost of production rise and lead to an increase in prices of finished goods. I still remember 2007-2008 before the housing crisis, oil prices went up. As a result, the price of everything went up. As a result, some people could not afford to make their payments because their payment resetted, their payment went up. They had those resetted interest rate and this is what kind of, that's one trigger of the housing crisis 2007-2008. My experience in this is I still remember I was still in public accounting at that time. I used to, once a week, I used to visit a pizza place in downtown Bethlehem. This is what I used to work. And I still remember that note the pizza owner put because of the increase in gas prices, there was an increase in the cost of the cheese. As a result, he was increasing the cost of the pizza. It's still in my mind kind of how things connect. So the increase in inflation rates over the near term can lead to higher nominal interest rate. Of course, because remember, the nominal rate part of it is inflation. So if inflation goes up, inflation is added to the real rate. The real rate plus the inflation equal to the nominal rate, so the nominal rate will go up. Also, with raw material more expensive because again, the cost of production, the productive capacity of the economy is reduced. Why? Because the ability of the individual to purchase now is at higher prices. So here's what happened. Prices go up, you buy, you buy less and the cost of production will go up as well. So it's not really a good combination. Therefore, GDP tend to fall when we have a supply shock. Other examples will be freezes, floods like the freezes of the oranges. What happened when we have that prices go up, droughts that might destroy large quantities of agricultural crops could also be the change in the educational level of an economy's workforce or change in the wage rate at which the labor force is willing to work. If the cost of labor goes up, then the cost of production goes up, just like the cost of oil. It's part of the input of the input of our economy. Just so I want to just kind of snip this story from this. This is around late March, early April. I don't remember. I don't have a date on it. I saved it on my phone. And basically, this is a classic negative supply and demand shock at the same time. McDonald's streaming its menu as long as the coronavirus pandemic persists. So this is basically a supply chain. They're not producing as more in order to deal with both. Failing customer traffic because there is not enough demand. There's a negative demand and staffing is labor negative supply. So this is negative supply and negative demand at the same time. And this is why this coronavirus, this pandemic is really very hurtful because it's hurting both supply and demand. Again, as of October, our economy is to a great degree. Many industries are benefiting the, the Amazons afterward, the technology, Apple, all these companies zoom Netflix. They're benefiting from this. They're benefiting from this. Other companies are not. Okay. So for example, McDonald is not doing as well. The restaurant chain said the move is an attempt to simplify its operation. Basically, the move is to increase earnings per share. Basically, cut down costs so you can survive. That's basically what it is. So how can we relate all of this to demand supply to what we do in this course, which is investments? Well, basically what you want to do is you want to identify the industries that most that that are most held or hurt from this supply and demand, whether that those shocks are positive or negative. For example, what happened if you forecast tightening of the money supply, you might to avoid the auto industry. Why? Because you're not going to have a lot of lending. If people can buy their cars auto industries will not be doing as well. They're also hurt by the increase in interest rate homes also are if interest rate goes up home prices go down. At the end of the day, everything that we talk about here, everything in economy, in my opinion, is an art rather than a science. So you have to take everything not with a grain of salt. You have to take everything with a context. And it's always you can bring two experts and they can give you two different opinion about the same data or the same perceived data, economic data. In the next session, we would look at the role of the Federal Reserve in the government in general federal government. As always, I would like to remind you to visit my website, Farhat lectures outcome for additional resources for this as well as other courses. Good luck. Study hard and most importantly.