Loading the player...

What is 'Cost-Push Inflation'

Cost-push inflation is a situation in which the overall price levels go up (inflation) due to increases in the cost of wages and raw materials.

Cost-push inflation develops because the higher costs of production factors decreases in aggregate supply (the amount of total production) in the economy. Since there are fewer goods being produced (supply weakens) and demand for these goods remains consistent, the prices of finished goods increase (inflation).

BREAKING DOWN 'Cost-Push Inflation'

The most common cause of cost-push inflation starts with an increase in the cost of production, which may be unexpected. This can be related to an increase in the cost of raw materials, unexpected damage or shutdown to a production facility (such as one caused by a fire of natural disaster), or mandatory wage increases for production employees, including instances where a rise in minimum wage automatically increases the compensation of employees who were being paid below the new standard.

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.

Unexpected Causes of Cost-Push Inflation

One common unexpected cause is a natural disaster. This can include floods, earthquakes, tornadoes or any other large disaster that disrupts any portion of the production chain and leads to increased production costs. Not all natural disasters may qualify, as not all of them result in higher production costs.

Other activities may qualify if they lead to higher production costs. This can include a worker strike, such as one relating to contract negotiations, or a sudden change in government (more often seen in developing nations) that affects the country’s ability to maintain previous output.

Expected Causes of Cost-Push Inflation

While a sudden change in government may be considered unexpected, changes in current laws and regulations may be anticipated even though there may be no reasonable way to compensate for the increased costs associated with them.

Cost-Push vs. Demand-Pull

The opposite of cost-push inflation, where increased production costs drive the price of a particular good or service up, is demand-pull inflation. Demand-pull inflation includes times when an increase in demand is experienced and production cannot be increased to meet changing needs. In these cases, product costs rise as a reflection of the imbalance in the supply and demand model.

Example of Cost-Push Inflation

In the early 1970s, the Organization of the Petroleum Exporting Countries (OPEC) wanted a monopoly over oil prices and tried to decrease the global oil supply by raising prices. The group's attempt to raise the price resulted in a supply shock. This is a good example of cost-push inflation, as there was no increase in demand for the commodity. 

RELATED TERMS
  1. Headline Inflation

    The raw inflation figure as reported through the Consumer Price ...
  2. Inflation Protected

    The types of investments that provide protection against inflation ...
  3. Core Inflation

    Core inflation is the change in prices of goods and services ...
  4. Inflation Targeting

    Inflation targeting is a central banking policy that revolves ...
  5. Law of Supply and Demand

    The law of supply and demand explains the interaction between ...
  6. Price Level Targeting

    Price level targeting is a monetary policy framework which commits ...
Related Articles
  1. Insights

    The Importance Of Inflation And GDP

    Learn the underlying theories behind these concepts and what they can mean for your portfolio.
  2. Insights

    Inflation's Impact on Stock Returns

    Learn about the impact inflation can have on stock returns. Find information on what types of stocks perform during times of high inflation or low inflation.
  3. Insights

    A Primer On Inflation

    Inflation has a negative connotation, but is it all bad or does it offer some tangible benefits?
  4. Insights

    Should You Worry About the U.S Inflation rate?

    Understand how inflation is measured, how U.S. inflation compares to other countries, and if investors should be concerned with rising inflation.
  5. Insights

    How Inflation Rates Impact Your Retirement Savings

    Understanding the risks and likely rate of inflation can help investors craft a strategically, well-diversified retirement portfolio.
  6. Insights

    Stagflation, 1970s Style

    Find out how Milton Friedman's monetarist theory helped bring the U.S. out of the economic doldrums.
  7. Insights

    How Inflation Affects Your Net Worth

    When calculating your net worth, don't forget to take inflation into account.
RELATED FAQS
  1. How does money supply affect inflation?

    Learn about two competing economic theories of the role of the money supply and whether money supply causes inflation in ... Read Answer >>
  2. What is inflation and how should it affect my investing?

    The rate of inflation is important as it represents the rate at which the real value of an investment is eroded and the loss ... Read Answer >>
  3. How Can Inflation Be Good for the Economy?

    Find out why some economists and public policy makers believe that inflation is a good, or even necessary, phenomenon to ... Read Answer >>
  4. Why Are P/E Ratios Higher When Inflation Is Low?

    P/E ratios are generally higher during times of low inflation, but why is this the case? Read Answer >>
  5. What impact does inflation have on the time value of money?

    Understand the impact that inflation has on the time value of money. Learn what you can do to mitigate the effects of inflation ... Read Answer >>
Hot Definitions
  1. Net Present Value - NPV

    Net Present Value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows ...
  2. Price-Earnings Ratio - P/E Ratio

    The Price-to-Earnings Ratio or P/E ratio is a ratio for valuing a company that measures its current share price relative ...
  3. Internal Rate of Return - IRR

    Internal Rate of Return (IRR) is a metric used in capital budgeting to estimate the profitability of potential investments.
  4. Limit Order

    An order placed with a brokerage to buy or sell a set number of shares at a specified price or better.
  5. Current Ratio

    The current ratio is a liquidity ratio that measures a company's ability to pay short-term and long-term obligations.
  6. Return on Investment (ROI)

    Return on Investment (ROI) is a performance measure used to evaluate the efficiency of an investment or compare the efficiency ...
Trading Center