Cost-push inflation

Definition

Cost-push inflation is a type of inflation that occurs when the overall prices rise due to increasing costs of production and raw materials. This kind of inflation typically happens when supply shocks, such as natural disasters or rising oil prices, force producers to pass on their higher costs to consumers in the form of increased prices. Understanding this concept helps to connect how inflation affects the economy, the factors that cause inflation, and the methods used to measure it.

5 Must Know Facts For Your Next Test

1. Cost-push inflation can lead to stagflation, where the economy experiences stagnant growth along with high inflation.
2. Key drivers of cost-push inflation include rising wages, increased costs for raw materials, and supply chain disruptions.
3. Governments may respond to cost-push inflation by implementing price controls or subsidies, although these can have negative side effects.
4. This type of inflation can erode purchasing power, making it more difficult for consumers to afford basic goods and services.
5. Cost-push inflation is often harder to control than demand-pull inflation since it stems from external supply factors rather than internal demand pressures.

Review Questions

• How does cost-push inflation differ from demand-pull inflation in terms of causes and effects?
  • Cost-push inflation differs from demand-pull inflation primarily in its causes; it arises from increased production costs, such as higher wages or raw material prices, while demand-pull inflation occurs when consumer demand outstrips supply. The effects also vary; cost-push inflation can result in reduced economic growth due to rising prices that may lead consumers to cut back on spending. In contrast, demand-pull inflation often signifies a growing economy but can lead to unsustainable price increases if not kept in check.
• What role do supply shocks play in triggering cost-push inflation, and what might be some examples of these shocks?
  • Supply shocks play a critical role in triggering cost-push inflation by disrupting the normal flow of goods and services, resulting in higher production costs. Examples include natural disasters like hurricanes that destroy infrastructure or crops, geopolitical events that restrict oil supply, or sudden changes in trade policies that affect availability and prices of raw materials. These shocks force producers to raise prices to maintain profit margins, leading to overall price increases in the economy.
• Evaluate the long-term implications of persistent cost-push inflation on economic policy and consumer behavior.
  • Persistent cost-push inflation can significantly influence economic policy by prompting central banks and governments to implement measures like interest rate hikes or regulatory changes to stabilize prices. However, if these policies are not effective or lead to further economic stagnation, they may result in a loss of consumer confidence and spending power. Over time, consumers may adapt by changing their buying habits, opting for cheaper substitutes or reducing discretionary spending altogether, which can further slow economic growth and complicate recovery efforts.

Related terms

Demand-pull inflation: A type of inflation that occurs when demand for goods and services exceeds their supply, leading to increased prices.

Inflation rate: The percentage change in the price level of goods and services over a specified period, often measured using indices like the Consumer Price Index (CPI).

Supply shock: An unexpected event that causes a sudden increase or decrease in supply, affecting prices and production.