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Cost Push Inflation

Cost-push inflation occurs when increases in the costs of important goods or services, like the rise in oil prices in the 1970s, cause a general increase in the price level. Since oil is essential to industrialized economies, a large increase in its price can lead to higher prices for most products and a higher inflation rate. Keynesians argue that instead of prices falling in response to a supply shock, it would cause a recession with rising unemployment and falling GDP. Monetarists dispute that increases in the costs of goods alone can cause inflation, arguing that if the money supply stays constant, any price increases would be offset by decreases in other prices.

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256 views2 pages

Cost Push Inflation

Cost-push inflation occurs when increases in the costs of important goods or services, like the rise in oil prices in the 1970s, cause a general increase in the price level. Since oil is essential to industrialized economies, a large increase in its price can lead to higher prices for most products and a higher inflation rate. Keynesians argue that instead of prices falling in response to a supply shock, it would cause a recession with rising unemployment and falling GDP. Monetarists dispute that increases in the costs of goods alone can cause inflation, arguing that if the money supply stays constant, any price increases would be offset by decreases in other prices.

Uploaded by

Manoj K
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Cost-push inflation

Aggregate Supply-Aggregate Demand model illustration of aggregate supply (AS) shifting to AS' and
causing price level to increase while output shrinks

Cost-push inflation is a type of inflation caused by substantial increases in the cost of important goods or
services where no suitable alternative is available. A situation that has been often cited of this was the
oil crisis of the 1970s, which some economists see as a major cause of the inflation experienced in the
Western world in that decade. It is argued that this inflation resulted from increases in the cost of
petroleum imposed by the member states of OPEC. Since petroleum is so important to industrialised
economies, a large increase in its price can lead to the increase in the price of most products, raising the
inflation rate. This can raise the normal or built-in inflation rate, reflecting adaptive expectations and the
price/wage spiral, so that a supply shock
can have persistent effects.

Keynesians argue that in a modern


industrial economy, many prices are sticky
downward or downward inflexible, so that
instead of prices falling in this story, a
supply shock would cause a recession, i.e.,
rising unemployment and falling gross
domestic product. It is the costs of such a
recession that likely causes governments
and central banks to allow a supply shock
to result in inflation. They also note that
though there was no deflation in the 1980s,
there was a definite fall in the inflation rate
during this period. Actual deflation was
prevented because supply shocks are not
the only cause of inflation; in terms of the modern triangle model of inflation, supply-driven deflation
was counteracted by demand pull inflation and built-in inflation resulting from adaptive expectations
and the price/wage spiral.

Monetarist economists such as Milton Friedman argue against the concept of cost-push inflation
because increases in the cost of goods and services do not lead to inflation without the government and
its central bank cooperating in increasing the money supply. The argument is that if the money supply is
constant, increases in the cost of a good or service will decrease the money available for other goods
and services, and therefore the price of some those goods will fall and offset the rise in price of those
goods whose prices have increased. One consequence of this is that monetarist economists do not
believe that the rise in the cost of oil was a direct cause of the inflation of the 1970s. They argue that
although the price of oil went back down in the 1980s, there was no corresponding deflation.
Cost Push Inflation and the Global economic slowdown
The world economy is slowing down, particularly in the OECD countries. This is blamed mainly on the
credit crisis, and the prices of raw materials. The price of oil increased by 40% in just a year, reaching a
peak of almost $140 a barrel in July 2008 (BBC News).Other raw materials such as wheat and steel saw
similar increases. This means that costs increased for manufacturers who use these raw materials in
production. Transportation and energy for industry and the service sector will also cost more as oil and
gas increase in price. The result is a huge increase in business costs, and this cost is often passed on to
the consumer, and so we have cost push inflation. There has been evidence of businesses shedding jobs
in order to cut costs, and a number of airlines such as Silverjet have gone out of business as a result of
high fuel prices.

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