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What is Cost-Push Inflation?
Cost-push inflation is a condition in which the cost of labor or raw materials goes up and causes an increase in prices for goods and services. Rapid changes in supply, called supply-side shocks lead to cost-push inflation. This type of inflation can be contrasted with demand-pull inflation, where there is an increase in the demand of goods and services that drives prices up.
Any inflation in an economy can be quite damaging by eroding consumers' purchasing power unless wages keep up with the increase in prices. Cost-push inflation isn't any different and often is the result of businesses passing on the increase in production to consumers.
Cost-push inflation is unlikely to occur unless demand for the affected products remains steady or is growing.
Graphic Representation of Cost-Push Inflation
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Cost-Pull vs. Demand-Pull
Cost-push inflation can be contrasted with demand-pull inflation, which occurs when there is an increase in the demand for a product that causes the price to rise due to competition among consumers wanting it more than others (e.g., people buying Apple products). Consumer behavior causes demand-pull inflation to happen while supply chain events cause cost-pull inflation to occur.
Causes of Cost-Push Inflation
Generally, any factor that increases costs for producers in the supply chain can lead to cost-push inflation. Let's look at some common things that can drive up production costs and lead to cost-push inflation.
1. Increased Labor Costs
If wages increase without corresponding productivity gains, as might happen if unions successfully negotiate higher pay rates, companies will have less money left over after paying their workers' salaries. Increased labor costs can be passed on to the consumer by increasing the total price of the final product.
2. Increased Taxes
If a government imposes new taxes on specific goods or on importing and exporting specific goods, then these costs could increase the total production cost of a product. These costs either create a smaller profit for the business or, more likely, a higher cost to the consumer.
3. Raw Materials Become Scarce
Sometimes it becomes difficult to find raw materials because of a natural disaster, war, or another event that disrupts the usual flow of materials. When this happens, companies will pass on these increased production costs to consumers by increasing the total price of a final product.
Other events might lead to cost-push inflation if it causes production costs to rise. This can be due to limited supply, higher demand, or government influence.
Pros & Cons of Cost-Push Inflation
Inflation is often thought of as a bad thing by consumers, but there can be both pros and cons when it happens. Below are the most common pros and cons of cost-push inflation, which are pretty similar to any type of inflation.
Pros of Cost-Push Inflation
- Higher Wages for Workers: Production cost increases that are related to higher pay levels result in workers with more economic might. This is good news for those workers.
- Increased Consumer Spending Power: During the initial stages of inflation, consumers have an increased level of spending power, especially if interest rates haven't yet adjusted. This can create economic growth and spur strong spending behaviors.
- Higher profit margins for suppliers: If supply shortages are at the root of the cost-push inflation, suppliers may be able to charge higher prices and reap higher margins. Shareholders of these companies may benefit as a result.
Cons of Cost-Push Inflation
- Increased Prices: The result of any inflation is going to be increased prices on goods or services. This can impact spending behavior if consumers aren't able to receive more pay for their work as they'll have less to spend on products that cost more.
- Decreasing Demand: If jobs and wages aren't increased then inflation actually can cause a decrease in demand. If consumers have less money to spend then they won't be able to keep up spending at higher prices.
- Creates Uncertainty: One of the biggest problems with inflation is that it creates uncertainty with consumers, investors, and businesses alike. Businesses and consumers are less likely to make decisions when there is so much unknown about the future as the effects of inflation take place. This can lead to a decrease in spending and investment, which is typically detrimental to the economy.
Cost-Push Inflation Example
One example of when cost-push inflation happened is the oil crisis in 1973 - 1974 when OPEC cut production by more than 25% due to political instability in the Middle East region. This caused an increase not only for gasoline but also for heating oil, which led to a jump in the Consumer Price Index (CPI) of almost 11%.
Now let's look at an example of how cost-push inflation might impact a single business. Assume a company named "Fixture10" creates light fixtures for consumers. Recently, Fixture10 came out with a new fixture that was shown off on a popular TikTok video by a celebrity. This drove demand up quite a bit for this new light.
With demand up, Fixture10 wanted to capitalize while they could and sell as many products as possible. So they needed to hire more employees and purchase more raw materials in order to make the light fixtures. Unfortunately, their supplier didn't have enough materials so they had to purchase them from alternative suppliers at a higher cost.
In order to meet the demand for their light fixtures, Fixture10 had to pay more to produce more lights. In turn, they raised prices on these popular fixtures in order to pass that cost on to the consumers instead of taking less profit. This is a classic example of how cost-push inflation happens.
Bottom Line
Cost-push inflation is a type of inflation that is caused by the increase in the cost of labor and materials. When this happens, it causes prices for goods and services to go up, resulting in decreased supply. This can be contrasted with demand-pull inflation, which occurs when there is an increase in demand that drives prices up.
