A Business Encyclopedia

Cost-push Inflation

Definition: The Cost-Push Inflation occurs when the price rise due to the increase in the price of factors of production, Viz. Labor, raw materials, and other inputs which are essential for the final production of a product. As a result, the aggregate supply decreases, demand remaining the same, an increase in the price of commodities leads to an overall increase in the general price level.

Often, the cost-push inflation is caused by the monopolistic groups in the society such as labor unions and firms operating in monopolistic and oligopolistic market setting. The following are the major kinds of cost-push inflation:

  1. Wage-push Inflation: The Strong labor unions force the money wages to go up, due to which the price increases. This kind of rise in the general price level is called as wage-push inflation. The powerful and well-organized labor unions exercise their monopoly power and compel their employers to increase their wages above the competitive level irrespective of their productivity (output).

    An increase in wage money brings a corresponding increase in the cost of production and this increase in the cost of production causes an aggregate supply curve to shift backward (aggregate supply decreases).  A backward shift in the aggregate supply causes the prices level to go up. It is to be noted that every time a rise in the wage money is not considered to be inflationary. The following conditions supplement this:

  • Increase in wage rate due to an increase in the productivity.
  • Rise in wage rate due to inflation caused by other factors.
  • Rise in wage where the unionized wage bill is very small.
  • Wage rises due to the shortage of labor.
  1. Profit-push Inflation: The profit-push inflation is attributed to the monopoly power exercised by the firms under the monopolistic and oligopolistic market that tries to enhance their profit margins by keeping the prices relatively high.

    The wage-push inflation and profit-push inflation goes hand-in-hand, which means as the labor unions force their employer to increase their wage money the cost of production also increases. And in order to meet the increased cost, the monopolistic and oligopolistic firms raise the price level often more than proportionately. This is done to enhance the profit margins of the firm. If this process of; a hike in the price of the commodity following an increase in the wage money continues, then this is called as ‘profit-wage spiral.’

  2. Supply-Shock Inflation: This kind of cost-push inflation is caused due to an unexpected decline in the supply of major consumer goods and key industrial inputs. Such as the prices of food product shoots up due to a crop failure and the prices of key industrial inputs Viz. Coal, iron, steel, etc., increases because of the natural calamities, lockouts, labor strikes, etc.

    Also, the prices may rise due to the supply bottlenecks in the domestic economy or international events (generally, war), thereby restricting the movement of internationally traded goods. As a result, the supply decreases and the import of industrial inputs increases.

Thus, these are the major kinds of cost-push inflation that show the supply side being responsible for the inflation in the economy, i.e. fall in supply results in a rise in the general price level.

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