Cost push inflation occurs when supply costs rise or supply levels fall. As long as demand remains the same either will drive up prices. Cost push inflation is created by Shortages or cost increases in labor, raw materials, and capital goods.
Definition
Cost-push inflation occurs when firms respond to rising costs by increasing prices in order to protect their profit margins.
Under costpush inflation, price rise due to rise in the cost of raw materials and wages. Sometimes, some producers or workers may raise the prices of their products above the level which prevails in the market. It has been seen that during recession period aggregate demand decrease than supply then prices should also decrease but it did not happen. Higher wages leads to increase in prices thus is creates wage push inflation which is a part of cost push inflation. Not only labour unions but monopolistic and oligopolistic also increase their profit margin and increase the prices which is known as profit push inflation. Similarly, there can be supply shock inflation
Causes of cost push inflation
- Monopoly- Cost-push inflation developed by companies that achieve a monopoly over an industry. A monopoly reduces supply to meet its profit goal.
- Wage inflation – Wage inflation is when workers have enough leverage to force through wage increases. When people expect higher inflation wage may increase in order to protect their real incomes.
- Component cost – it involves increase in the prices of raw materials and other components. This is due to the rise in commodity prices such as oil, copper and agricultural products used in food processing.
- Higher indirect taxes – government regulation and taxation may reduce the supply of many other products such as rise in the duty on alcohol, fuels and cigarettes, or a rise in Value Added Tax.
- Exchange rates – higher import prices happens when any country that allows the value of its currency to fall. The foreign supplier does not want the value of its product to drop along with that of the currency. It can raise the price and keep its profit margin intact, if demand is inelastic.
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