Cost Push Inflation in detail

A steady but gradual increase in prices is a sign of a healthy economy. This long-term increase in prices is known as inflation. Price inflation can occur for a variety of reasons.

In general terms, an overall increase in prices due to increase in the cost of raw materials and wages is called Cost Push Inflation.

Shortages or cost increases in labor, raw materials, and capital goods create cost-push inflation. These components of supply are also part of the four factors of production.

It  is different from demand-pull inflation which occurs when aggregate demand grows faster than aggregate supply.

CAUSES OF COST PUSH INFLATION

There are four principal factors of production: labor, capital, land, or entrepreneurship. When any one of these rises, it can be the cause of price increases throughout an industry. The main causes of cost push inflation are stated as below –

  1. Higher Wages – Wages are one of the main costs facing firms. Rising wages will push up prices as firms have to pay higher costs (higher wages may also cause rising demand)
  2. Monopoly – Companies that achieve a monopoly over an industry can create cost-push inflation. A monopoly reduces supply to meet its profit goal.
  3. Shifting Exchange Rates – A fall in the exchange rate can cause cost push inflation because it normally leads to an increase in the prices of imported products. For example during 2007-08 the pound fell heavily against the Euro leading to a jump in the prices of imported materials from Euro Zone countries.
  4. Government taxes – Higher VAT and Excise duties imposed by government will increase the prices of goods. This price increase will be a temporary increase.
  5. Natural Disasters – Cost push inflation can also be caused due to natural disasters such as floods, earthquakes etc. by disrupting the supplies.

HOW TO REDUCE COST PUSH INFLATION ?

The government can use a range of domestic policies to reduce and prevent the negative impacts of cost-push inflation.

In addition to this, pursuing deflationary fiscal policy (higher taxes, lower spending) or  increase in  interest rates would increase the cost of borrowing and reduce consumer spending and investment.

The long-term solution to cost-push inflation could be better supply-side policies which help to increase productivity and shift the AS curve to the right. But, these policies would take a long time to have an effect.

 

Thus, in simple words Cost push inflation can be defined as a rising general price level caused by an increase in the costs of production which may lead to lower economic growth & a fall in living standards.

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