Cost-Push Inflation

Idea

Cost-push inflation arises when aggregate supply falls because of a widespread increase in the costs of production, for reasons unconnected to any rise in aggregate demand. Where demand-pull inflation pulls prices up from the demand side, cost-push pushes them up from the supply side.

Mechanism

A broad-based rise in production costs reduces the quantity firms are willing to supply at any given price, shifting the aggregate-supply curve up and to the left. The general price level rises and, unlike demand-pull inflation, real output falls — the simultaneous rise in prices and contraction in output is stagflation.

Diagram

Cost-push inflation: a widespread rise in production costs shifts aggregate supply up and to the left from AS₀ to AS₁, with aggregate demand AD₀ unchanged. The general price level rises from P₀ to P₁ while real national output falls from Y₀ to Y₁.

Considerations

Several sources of rising cost are distinguished:

Imported inflation — raw materials and inputs are imported from countries that are themselves inflating, raising domestic production costs. Relevant chiefly to small, open economies such as Singapore that depend heavily on imported inputs.
Wage-push inflation — wages rise faster than labour productivity, so the cost per unit of output rises even though output per worker is unchanged.
Profit-push inflation — firms with significant market power raise prices to widen margins, sustainable where demand is price-inelastic for want of close substitutes.
Negative supply shocks — unexpected events (for example, the 1995 Kobe earthquake) that sharply reduce the supply of key goods, raising costs across the economy.
Statutory inflation — government measures such as tax hikes, licensing fees and regulation that raise costs; Singapore’s GST increase and its road-pricing schemes (COE, ERP) are examples.