Cost-Push Inflation Explained, with Causes and Examples
Cost-push inflation is when the costs of supply rise or the level of supply falls. Either will make the prices rise in the final good or service if demand remains the same. Supply is either labor, raw materials, or capital. It is one of the four factors of production.
The four main types of inflation are creeping, walking, galloping, and hyperinflation.
Cost-push inflation occurs when demand is inelastic. Demand is inelastic when there is a high demand for the good or service even if the price goes up. For example, inelastic demand occurs with gasoline. People can't easily buy less gas no matter how high the price goes. It's even worse for those who don't have good alternatives, such as mass transit. It takes time for people to find alternatives, such as joining a carpool or buying a fuel-efficient vehicle. Until then, they need the same amount of gas.
When demand is elastic, people won't pay the higher prices. They simply buy less of the good or service. They'll either switch to a slightly different product or do without it. A good example of this is single family homes. Obviously, people can't do without housing. But if prices rise, they have other options.
They can rent, buy townhomes or condos, or live with friends or relatives. Higher housing prices and higher gas prices are just some of the ways that inflation impacts your life. Fortunately, the Federal Reserve does a lot to control inflation.
Five Causes of Cost-Push Inflation
Cost-push inflation occurs under five special circumstances.
In all of these circumstances, demand is inelastic.
A good example is the Organization of Petroleum Exporting Countries. It sought monopoly power over oil prices. Before OPEC, its members competed with each other on price. They didn't receive a reasonable value for a non-renewable natural resource. OPEC members now produce 42 percent of oil each year. They control 80 percent of the world's proven oil reserves. OPEC members created cost-push inflation during the 1970s oil embargo. When OPEC restricted oil in 1973, it quadrupled prices. In 2014, shale oil producers challenged OPEC's monopoly power. Prices dropped as a result. They created a U.S. shale oil boom and bust.
2. Wage inflation
Wage inflation occurs when workers have enough leverage to force through wage increases. Companies then pass higher costs through to consumers. The U.S. auto industry experienced it when labor unions were able to push for higher wages. Thanks to China and the decline of union power in the United States, it hasn't been a driver of inflation for many years.
3. Natural Disasters.
Natural disasters cause inflation by disrupting supply. A good example is right after Japan's earthquake in 2011. It disrupted the supply of auto parts. It also occurred after Hurricane Katrina. When the storm destroyed oil refineries, gas prices soared.
The depletion of natural resources is a type of natural disaster. It works the same way, by limiting supply and causing inflation. For example, fish prices are rising due to overfishing. Recent U.S. laws try to prevent it by limiting the catch for fishermen.
4. Government Regulation and Taxation
A fourth driver is government regulation and taxation. These rules can reduce supplies of many other products. Taxes on cigarettes and alcohol were meant to lower demand for these unhealthy products. That may have happened, but more importantly, it raised the price and created inflation.
Government subsidies of ethanol production led to soaring food prices in 2008. Agribusinesses grew corn for energy production, taking it out of the food supply. Food prices were so high that there were food riots around the world that year.
5. Exchange Rates
The fifth reason is a shift in exchange rates. Any country that allows the value of its currency to fall will experience higher import prices. The foreign supplier does not want the value of its product to drop along with that of the currency. If demand is inelastic, it can raise the price and keep its profit margin intact.