What Is Cost-Push Inflation? With Causes and Examples

The 5 Causes of Cost-push Inflation

cost basis inflation
Marlin is expensive due to decades of overfishing. Photo: Silvestre Machado/Getty Images

Definition: Cost-push inflation is when supply costs increase or the level of supply decreases. Prices rise in the final good or service if demand remains the same. Supply can be either labor, raw materials, or capital.  For more, see Four Factors of Production.

It is one of the two causes of inflation. The other is demand-pull inflation, which also includes expansion of the money supply

Cost-push inflation only occurs when demand is inelastic.

That means there is a high demand for the good or service even if the price goes up. Inelastic demand occurs with gasoline. People can't easily buy less gas no matter how high the price goes. That's especially true where there aren't 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.

5 Causes

Cost-push inflation occurs under five special circumstances. In all of these circumstances, demand is inelastic.

First, companies that achieve a monopoly over an industry create cost-push inflation. A monopoly reduces supply to meet its profit goal.

A good example is OPEC, 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. For more, see U.S. Shale Oil Boom and Bust.

Wage inflation is the second creator of cost-push inflation. That's when workers have enough leverage to force through wage increases. Companies then pass higher costs through to consumers. That happened in the U.S. auto industry when the labor unions were able to push for higher wages. Thanks to China and the decline of union power in the United States, this has not been a driver of inflation for many years.

Natural disasters are a third catalyst for cost-push inflation. An 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.

A related natural disaster is the depletion of natural resources. For example, fish prices are rising due to overfishing.

Recent U.S. laws try to prevent it by limiting the catch for fishermen.

A fourth driver of cost-push inflation 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 important it raised the price, creating inflation. Government subsidies of ethanol production led to soaring food prices in 2008. That's because 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.

The fifth reason for cost-push inflation is a shift in exchange rates. Any country that allows the value of its currency to fall will experience higher import prices.

That's because 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. (Source: "Cost-Push Inflation," The Intelligent Economist. "Cost-Push Inflation," Biz/Ed.) 

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