Inflation
caused by higher costs feeding into higher prices is called cost-push inflation. Costs represent
payment made for the services of the factors of production. The prices of
materials, labour and capital may rise even when there is no excess demand in
the economy.
In
the diagram increase in the cost of production shifts the supply
curve leftwards to S1. The increase in the cost of production
pushes the price level upwards.
The
following are the possible reasons for
cost-push inflation.
(1)
Increase in wage rate. When
wages increase faster than productivity, cost of production will increase and
causes increase in the price level.
(2)
Increase in the price of raw materials.
As the prices of raw material increases, the cost of production will increases
the price level.
(3)
Indirect tax. Indirect taxes are
added to the price of the product and thus price level is pushed upwards.
Increased
costs of production encourage firms to raise prices is an impact which is known
as cost-push inflation. This may encourage workers in the other
industries to press for wage rises. This higher wages will be likely
to lead to increased expenditure on production, which may lead to demand-pull
inflation.
On
the other hand if output rises by more labour productivity then the higher
wage may not raise costs. The increased wage rise will be neutralised by
the increased productivity. This may also lead to more export openings
than in the domestic market.
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