World Blog by humble servant. What is COST PUSH inflation. The cause and effect . Policy decision leading to.

What Is Cost-Push Inflation? Cost-push inflation (also known as wage-push inflation) occurs when overall prices increase (inflation) due to increases in the cost of wages and raw materials. Higher costs of production can decrease the aggregate supply (the amount of total production) in the economy. Since the demand for goods hasn't changed, the price increases from production are passed onto consumers creating cost-push inflation. Cost-push inflation can be compared with demand-pull inflation. KEY TAKEAWAYS Cost-push inflation occurs when overall prices increase (inflation) due to increases in the cost of wages and raw materials. Cost-push inflation can occur when higher costs of production decrease the aggregate supply (the amount of total production) in the economy. Since the demand for goods hasn't changed, the price increases from production are passed onto consumers creating cost-push inflation. 0:59 Cost-Push Inflation Understanding Cost-Push Inflation Inflation is a measure of the rate of price increases in an economy for a basket of selected goods and services. Inflation can erode a consumer's purchasing power if wages haven't increased enough or kept up with rising prices. If a company's production costs rise, the company's executive management might try to pass the additional costs onto consumers by raising the prices for their products. If the company doesn't raise prices, while production costs increase, the company's profits will decrease. The most common cause of cost-push inflation starts with an increase in the cost of production, which may be expected or unexpected. For example, the cost of raw materials or inventory used in production might increase, leading to higher costs. For cost-push inflation to take place, demand for the affected product must remain constant during the time the production cost changes are occurring. To compensate for the increased cost of production, producers raise the price to the consumer to maintain profit levels while keeping pace with expected demand. Causes of Cost-Push Inflation As stated earlier, an increase in the cost of input goods used in manufacturing, such as raw materials. For example, if companies use copper in the manufacturing process and the price of the metal suddenly rises, companies might pass those increased costs on to their customers. Increased labor costs can create cost-push inflation such as when mandatory wage increases for production employees due to an increase in the minimum wage per worker. A worker strike due to stalled contract negotiations might also lead to a decline in production; and as a result, lead to higher prices. Unexpected causes of cost-push inflation are often natural disasters, which can include floods, earthquakes, fires, or tornadoes. If a large disaster causes unexpected damage to a production facility and results in a shutdown or partial disruption of the production chain, higher production costs are likely to follow. A company might have no choice but to increase prices to help recoup some of the losses from a disaster. Although not all natural disasters result in higher production costs and therefore, wouldn't lead to cost-push inflation. Other events might qualify if they lead to higher production costs, such as a sudden change in government that affects the country’s ability to maintain its previous output. However, government-induced increases in production costs are more often seen in developing nations. Government regulations and changes in current laws, although usually anticipated, may cause costs to rise for businesses because they have no way to compensate for the increased costs associated with them. For example, the government might mandate that healthcare be provided, driving up the cost of employees or labor. Cost-Push vs. Demand-Pull Rising prices caused by consumers wanting more goods is called demand-pull inflation. Demand-pull inflation includes times when an increase in demand is so great that production can't keep up, which typically results in higher prices. In short, cost-push inflation is driven by supply costs while demand-pull inflation is driven by consumer demand—while both lead to higher prices passed onto consumers. Example of Cost-Push Inflation The Organization of the Petroleum Exporting Countries (OPEC) is a cartel that consists of 13 member countries that both produce and export oil. In the early 1970s, due to geopolitical events, OPEC imposed an oil embargo on the United States and other countries. OPEC banned oil exports to targeted countries and also imposed oil production cuts.1 What followed was a supply shock and a quadrupling of the price of oil from approximately $3 to $12 per barrel.2 Cost-push inflation ensued since there was no increase in demand for the commodity. The impact of the supply cut led to a surge in gas prices as well as higher production costs for companies that used petroleum products. What Causes Inflation? Inflation, or a general rise in prices, is thought to occur for several reasons, and the exact reasons are still debated by economists. Monetarist theories suggest that the money supply is the root of inflation, where more money in an economy leads to higher prices. Cost-push inflation theorizes that as costs to producers increase from things like rising wages, these higher costs are passed on to consumers. Demand-pull inflation takes the position that prices rise when aggregate demand exceeds the supply of available goods for sustained periods of time. Is Inflation Always Bad? In theory, a low amount of inflation can be a healthy sign of a growing economy. High inflation, however, can be damaging (but deflation, or declining prices, can be too). Note that inflation isn't always bad for certain groups of people. For example, borrowers at fixed interest rates tend to benefit from inflation while lenders and savers are hurt by it. What Is the Wage-Price Spiral? The wage-price spiral is a take on cost-push inflation argues that as wages rise, it creates more demand, which leads to higher prices. These higher prices thus incentivize workers to demand even higher wages, and so the cycle repeats. What Are Raw Materials? Raw materials are materials or substances used in the primary production or manufacturing of goods. Raw materials are commodities that are bought and sold on commodities exchanges worldwide. Traders buy and sell raw materials in the factor market because raw materials are factors of production, as are labor and capital. KEY TAKEAWAYS Raw materials are the input goods or inventory that a company needs to manufacture its products. Examples of raw materials include steel, oil, corn, grain, gasoline, lumber, forest resources, plastic, natural gas, coal, and minerals. Raw materials can be direct raw materials, which are directly used in the manufacturing process, such as wood for a chair. Indirect raw materials are not part of the final product but are instead used comprehensively in the production process. The value of direct raw materials inventory appears as a current asset on the balance sheet. 1:16 Aggregate Supply Explained Rising prices are typically an indicator that businesses should expand production to meet a higher level of aggregate demand. When demand increases amid constant supply, consumers compete for the goods available and, therefore, pay higher prices. This dynamic induces firms to increase output to sell more goods. The resulting supply increase causes prices to normalize and output to remain elevated. KEY TAKEAWAYS Total goods produced at a specific price point for a particular period are aggregate supply. Short-term changes in aggregate supply are impacted most significantly by increases or decreases in demand. Long-term changes in aggregate supply are impacted most significantly by new technology or other changes in an industry. Changes in Aggregate Supply A shift in aggregate supply can be attributed to many variables, including changes in the size and quality of labor, technological innovations, an increase in wages, an increase in production costs, changes in producer taxes, and subsidies and changes in inflation. Some of these factors lead to positive changes in aggregate supply while others cause aggregate supply to decline. For example, increased labor efficiency, perhaps through outsourcing or automation, raises supply output by decreasing the labor cost per unit of supply. By contrast, wage increases place downward pressure on aggregate supply by increasing production costs. Aggregate Supply Over the Short and Long Run In the short run, aggregate supply responds to higher demand (and prices) by increasing the use of current inputs in the production process. In the short run, the level of capital is fixed, and a company cannot, for example, erect a new factory or introduce a new technology to increase production efficiency. Instead, the company ramps up supply by getting more out of its existing factors of production, such as assigning workers more hours or increasing the use of existing technology. In the long run, however, aggregate supply is not affected by the price level and is driven only by improvements in productivity and efficiency. Such improvements include increases in the level of skill and education among workers, technological advancements, and increases in capital. Certain economic viewpoints, such as the Keynesian theory, assert that long-run aggregate supply is still price elastic up to a certain point. Once this point is reached, supply becomes insensitive to changes in price. Example of Aggregate Supply XYZ Corporation produces 100,000 widgets per quarter at a total expense of $1 million, but the cost of a critical component that accounts for 10% of that expense doubles in price because of a shortage of materials or other external factors. In that event, XYZ Corporation could produce only 90,909 widgets if it is still spending $1 million on production. This reduction would represent a decrease in aggregate supply. In this example, the lower aggregate supply could lead to demand exceeding output. That, coupled with the increase in production costs, is likely to lead to a rise in price.