Explain Mark up inflation
Mark-up theory of inflation was proposed by Prof Gardner Ackley. According to him,
inflation cannot occur alone by demand and cost factors, but it is the cumulative effect of
demand-pull and cost-push activities. Demand-pull inflation refers to the inflation that
occurs due to excess of aggregate demand, which further results in the increases in price
level. The increase in prices levels stimulates production, which increases demand for
factors of production. Consequently, the cost and price both increases.
Ackley’s simplified version of the analysis markup inflation is based on the assumption that
both wages and prices are “administered” and are settled by workers and business firms. Firms
fix administrative prices for their goods by adding to their direct material and labour costs, and
some standard markup which Covers profit. Labour also seeks wages on the basis of a fixed
markup over its cost of living. This model of inflation can lead to a stable, a rising, or a falling
price level depending on the markups which firms and workers respectively use.
This model of inflation can lead to a stable, a rising, or a falling price level depending on the
markups which firms and workers respectively use. If either or both use a percentage markup,
the inflation will progress faster than if either or both fix the markups in money terms. If each
participant fixes prices on the basis of prices he pays, the inflation will be high and of long
duration. If one firm raises its prices in order to maintain its desired markup, the costs of other
firms are raised which, in turn, raise their prices and this process of raising costs and prices
will spread to other firms in an endless chain.
When consumers buy such goods whose prices are rising, their cost of living rises. This causes
wage costs to rise, thereby increasing the inflationary spiral. However, the inflationary spiral
may come to a halt, if there is a gradual improvement in the efficiency and productivity of
labour. A rise in efficiency and productivity means that there is a rise in wage rates or prices of
materials leading to a smaller rise in labour and material costs. But stability in prices may not
come if firms and workers appropriate the gains of rising productivity by increasing their
markups. If each participant increases its markup by 100 per cent of the gains of productivity
increase, the inflationary spiral might continue indefinitely. According to Ackley, the markup
can be based on either historical experience or expectations of future costs and prices.
Moreover, the size of the markup applied by firms and workers is a function of the pressure of
demand felt in the economy. When the demand is moderate, the markups may be applied to
historically experienced costs and prices, and the price rise may be slow. But when demand is
intense, the markups are based on anticipations of future costs, and prices rise rapidly. Thus,
there can be no inflation without some change in the size of the markup. This theory can also
be applied to cost-push and demand-pull models of inflation. If firms and workers believe that
their markups are lower than the required costs and prices, regardless of the state of aggregate
demand, they will increase the size of their markups. Under such a situation, costs and prices
rise in an inflationary spiral. This is similar to the cost-push inflation. On the other hand, if
firms and workers raise the markups due to increase in demand, markup pricing is related to
demand-pull inflation. To conclude with Ackley, “Inflation might start from an initial
autonomous increase either in business and labour markups. Or it might start from an increase
in aggregate demand and which first and most directly affected some of the flexible market-
determined prices. But however it starts, the process involves the interaction of demand and
market elements.”
The markup inflation can be controlled by the usual monetary and fiscal tools in order to restrict
the demand for goods and increase productivity. Ackley also suggests wage-and-price
guidelines or an incomes policy to be administered by a national wage-and-price commission.
Criticisms:
Ackley’s theory suffers from weakness.
The theory gives a very limited explanation of the cause of inflation, especially the motives
which compel workers and firms to fix higher markups in the absence of demand conditions.
