Cost-Push Inflation

Definition

Cost-push inflation is a type of inflation where the general price level rises due to increases in the production costs of goods and services. This is in contrast to demand-pull inflation, where prices rise due to increased consumer demand. Cost-push inflation is a significant factor in understanding how the U.S. and other countries experience inflation, as well as its impact on aggregate supply, the Phillips Curve, and inflation in various regions.

5 Must Know Facts For Your Next Test

1. Cost-push inflation can be caused by factors such as rising wages, increased prices of raw materials, or supply chain disruptions.
2. In the AD/AS model, cost-push inflation is represented by a leftward shift in the aggregate supply curve, leading to higher prices and lower output.
3. Cost-push inflation can lead to a stagflation scenario, where high inflation coexists with high unemployment and stagnant economic growth.
4. The Phillips Curve relationship may break down during periods of cost-push inflation, as the inverse relationship between unemployment and inflation is disrupted.
5. Developing countries are often more susceptible to cost-push inflation due to their reliance on imported goods and vulnerability to external shocks.

Review Questions

• Explain how cost-push inflation is represented in the AD/AS model and how it differs from demand-pull inflation.
  • In the AD/AS model, cost-push inflation is represented by a leftward shift in the aggregate supply curve, indicating a decrease in the quantity of goods and services supplied at each price level. This is in contrast to demand-pull inflation, where the aggregate demand curve shifts to the right, leading to higher prices and increased output. The key difference is that cost-push inflation is driven by rising production costs, while demand-pull inflation is driven by increased consumer demand.
• Describe the potential impact of cost-push inflation on the Phillips Curve relationship and the overall economic performance.
  • Cost-push inflation can disrupt the traditional inverse relationship between unemployment and inflation depicted by the Phillips Curve. During periods of cost-push inflation, the economy may experience a combination of high inflation and high unemployment, a phenomenon known as stagflation. This situation challenges policymakers, as measures to address inflation, such as raising interest rates, may further exacerbate unemployment. The breakdown of the Phillips Curve relationship during cost-push inflation highlights the complex dynamics between inflation, unemployment, and economic growth.
• Analyze the factors that contribute to cost-push inflation in various countries and regions, and discuss the potential policy responses to mitigate its impact.
  • Developing countries are often more susceptible to cost-push inflation due to their reliance on imported goods and vulnerability to external shocks, such as fluctuations in commodity prices or supply chain disruptions. In these economies, policymakers may need to consider a combination of measures, including exchange rate management, subsidies or price controls, and investment in domestic production capacity to reduce dependence on imports. In developed economies, cost-push inflation may be driven by factors like rising wages or increased energy costs. In these cases, policymakers may need to carefully balance measures to address inflation, such as monetary policy tightening, with the potential impact on employment and economic growth.

Related terms

Aggregate Supply: The total quantity of goods and services that firms are willing to sell at different price levels in an economy.

Demand-Pull Inflation: A type of inflation where the general price level rises due to increased consumer demand for goods and services.

Phillips Curve: A graphical representation of the inverse relationship between the unemployment rate and the inflation rate in an economy.