Cost-Push Inflation

Cost-push inflation is defined as an increase in the general price level due to increases in input costs. In other words, it is a type of inflation that’s based on the rising costs for businesses. This rise in input costs can be caused by any number of things. For example, if there is a shortage of a natural resource needed to produce a good or service, then this will lead to an increase in the price of the good or service created with this natural resource.

Why Does It Happen?

Cost-push inflation can occur due to several reasons. The most common reason for cost-push inflation is a decrease in supply of a good or service that leads to a reduction of output. If suppliers are not able to produce as many goods or services as the market demands, then they will have to come up with a way to increase prices in order to maintain their profit margins. Another common reason for cost-push inflation is an increase in input costs for business owners. This can occur because of new laws passed that require businesses to incur additional costs in order to meet the new standards. In addition, there are also many more workers than there are managers in the industry, which makes it easier for workers to band together and demand higher wages/benefits. There is also a demand for labor that is inelastic, which means that consumers are less likely to switch to a cheaper product.

Examples of Cost-Push Inflation

Example 1

The most notable example of cost-push inflation in recent memory is the surge in oil prices that began in 2007. The primary cause for this was the unrest in the Middle East, which led OPEC to reduce production. Because there was less oil on the market, demand increased and so did prices at service stations across America.

Example 2

Another example comes from the first quarter of 2012. Laborers working for The Boeing Company were given a $10,000 signing bonus along with other incentives to help facilitate the 787 Dreamliner project. Unfortunately, this increased labor costs by $1 billion within the first quarter alone. To offset these higher labor costs, the company began outsourcing jobs to other countries, which was expected to save the company $1 billion by 2014. This cost-cutting measure led to higher ticket prices for flights on Boeing aircrafts (mostly because of increased overhead costs).

Example 3

During elections, the cost of labor increases because more people are working on the campaigns of various candidates. This increase in labor costs is seen by many campaigns as unavoidable, which leads them to raise prices for donors who contribute to their cause, especially if the campaign has no big name endorsers or donors.

Example 4

During the pandemic, the price of cotton increased due to cotton shortages. The economic impact on the United States was two-fold. Not only did the cost of producing clothes increase, but so did the price at retail because manufacturers had to pass on these higher costs to consumers.

Example 5

In 2021, terrorists attacked an oil refinery in Venezuela. This caused the price of oil to skyrocket, which led to higher prices for businesses (cars, transportation services, etc.) and consumers.

What Are the Effects of Cost-Push Inflation on an Economy?

Depending on how high inflation is in an economy, cost-push inflation can be very damaging. Inflation is defined as a sustained increase in the overall price level, which can cause people to buy less and save more. This increase in savings prevents businesses from expanding operations, which results in a decrease in employment rates. An increased unemployment rate means that there will be less money being spent on goods and services, thus reducing consumer demand. Another effect of cost-push inflation is that countries with fixed exchange rates are at a disadvantage. Fixed exchange rates are set by the government, which means they cannot be altered.

How to Prevent Cost-Push Inflation?

The main source of cost-push inflation is demand-pull inflation. In order to prevent this from happening, there must be a balance between supply and demand. If there is an increase in the supply of a product without increasing the demand for it, then there will be surpluses that have to be cut back on production or sold at a discount. For example, the number of cars produced in 2021 exceeded the demand for them by 10 million. This surplus meant that car manufacturers had to cut back on production or sell their cars at a discounted price. If there wasn’t enough demand for these extra cars, then companies could have stopped producing them altogether. Another way to prevent cost-push inflation is to not rely entirely on forces outside of the control of a company. For example, if an oil refinery in Venezuela was attacked by terrorists, then oil prices would likely decline due to increased supply coupled with decreased demand for oil because everyday citizens may be scared to travel. This means that oil companies could still produce as much oil as they can and sell it at a discounted price. Lastly, companies should not underestimate the power of advertisement. If companies can create demand for their products by advertising them on television or radio, then they will be able to drive up prices without having supply exceed demand.

Final Thoughts

There are many causes of cost-push inflation, but the most common one is demand-pull inflation. The best way to prevent cost-push inflation is for companies to not rely entirely on external forces for their products and market them better using advertisement campaigns.

In this type of inflation, the prices of goods and services go up because costs have gone up for businesses producing said goods.
There are several ways cost-push inflation can happen. For instance, there could be a decrease in supply which would lead to an increase in prices for goods and services. Another way is if there's increased demand for products but not enough supply to meet that demand.
Here's a situation in which cost-push inflation occurred: In 2020, there was an increase in oil demand due to a cold winter. However, the supply of oil decreased because Venezuela's state run oil refinery had been attacked by terrorists and it would take months for it to get back up and running. This decrease in supply led to higher prices for goods such as gasoline and heating bills.
The main effect of cost-push inflation is that it can cause consumers to buy less and save more because prices of goods are rising. This decrease in consumer spending can lead to the decline of businesses which will result in a decrease in employment rates. Another effect is that a country with a fixed exchange rate is at a disadvantage since they cannot adjust their currency's value from this inflation.
The best way to prevent cost-push inflation is to close the gap between supply and demand. Another way is for countries to change their fixed exchange rate to a floating exchange rate. Lastly, cost-push inflation can be prevented by increasing competition in an industry among companies so that it leads to greater productivity.

True Tamplin, BSc, CEPF®

About the Author
True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, or check out his speaker profile on the CFA Institute website.