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What is Cost-Push Inflation?

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  • Written By: Michael Pollick
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  • Last Modified Date: 27 August 2016
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Providing a brief, straightforward explanation for economic concepts is not always easy, but fortunately the theory of cost-push inflation can be explained in 500 words or less. Economics is largely about comparing different schools of thought, and the major proponent of the cost-push inflation model is a British economist named John Maynard Keynes. Keynes believed that the health of a country's economy depending on a mix of government and private controls. Under his economic model, cost-push inflation occurs whenever the cost of production suddenly rises but the demand for the product or service remains the same. This additional cost must be passed onto the consumer, which in turn increases the retail price.

There are a number of factors which could create cost-push inflation, but the two most obvious causes are wage increases and increased material costs, especially imported goods. The retail price of a product is often based on the current wages of the workers who produce it, so whenever workers receive raises in pay, the production costs increase as well. The company can't afford to absorb this increase internally, so the added expense of production is passed directly to consumers. Since the consumer's own wages may not have risen, the price increase is a form of cost-push inflation. The same dollar which could have bought the product last week can now only buy 90% of that product this week. This is what economists would call a lowering in spending power.

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Another cause of cost-push inflation is an increase in the cost of materials or services rendered to the manufacturer. If a foreign economy collapses, the cost of importing materials from that country can rise exponentially. The cost of delivering materials to the manufacturing plant might also increase dramatically during an energy crisis or extended strike. A manufacturer may decide to absorb some of these added expenses in order to maintain a competitive price, but not all of them. The result could be an increase in the retail price and a real-life demonstration of the cost-push inflation theory.

There is also an equal but opposite economic event called demand-pull inflation, which other economists besides Keynes tend to support as the root cause of most consumer price inflation. Unlike cost-pull inflation, demand-pull inflation is affected by demand for a product, not necessarily the available supply. When gasoline supplies become tight during a holiday season, for example, the price is likely to rise because of a higher demand for the product from vacationing drivers, not just the ebb and flow of oil production levels. Under the theory of depend-pull inflation, gasoline prices would increase because of higher wages for the oil workers or an increase in the price per barrel of unprocessed crude oil.

The argument against an increase in the federal minimum wage often includes a reference to cost-push inflation. If the base wages of workers is increased, then the manufacturers may feel obligated to pass these increases onto consumers in the form of higher prices. Since an increase in the minimum wage may not benefit workers who already receive higher salaries, their spending power may be reduced as a result of these price adjustments. The theory of cost-push inflation does suggest this scenario is possible, but historically the raising of the federal minimum wage has not resulted in long-term inflation, since other wage earners may also receive raises as well. A rising tide tends to lift all boats.

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anon150947
Post 5

The only meaningful (sufficient and necessary) definition of inflation relates to the expansion of money supply and credit; the Keynesian definitions serve only to obfuscate.

Crispety
Post 4

Sneakers41 -I hope that doesn’t happen. I also wanted to say that cost push inflation is also caused by winter frosts.

Many crops in Florida were affected due to the unseasonably cold temperatures. As a result not only are the grapes significantly smaller, but they are also $7 a bag.

The inflation is also affecting many consumer products like cereals. A lot of companies are reducing the content of their products by a few ounces but charging the same price.

This is how they are dealing with the rising prices of wheat.

sneakers41
Post 3

Subway11 -I just want to say that we can’t afford to raise interest rates because the housing market will never return to normal.

Not only that, but people will have difficulty buying cars and financing high ticket items. These industries will suffer because since people won’t be able to finance the items, they will be forced out of business.

Many businesses will close because they won’t be able to afford to borrow money in order to expand their business. It would be a terrible thing all around.

subway11
Post 2

Cupcake15 -I agree with you but what really scares me is the effects of inflation over the long haul.

The recent monetary policy of quantitative easing which increases our money supply risks inflation because we are debasing our currency every time we print more money.

Not only that but in order to get other countries to buy our debt we will have to raise interest rates in order for them to get a higher return on their investment. If we lose our AAA bond rating, the inflation effects will be dire.

cupcake15
Post 1

I have to respectfully disagree that raising the minimum wage is a good for us because we all receive increases.

The problem is that companies will compensate for the additional expense of raising a workers hourly wage by cutting elsewhere.

When the minimum wage is raised companies tend to lay off workers which raises the unemployment rate. While those that have a job might earn more, many more people will be without work as a result.

In addition, the increased cost is also passed on to the consumer which adds insult to injury when you have just lost your job.

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