Cost-Push Inflation
What is Cost-Push Inflation?
Cost-push inflation is a rise in the general price level caused by higher production costs, which shift short-run aggregate supply to the left.
Cost-push inflation occurs when there is an increase in the costs of production, such as wages or raw materials, which leads to an increase in prices. This type of inflation is often caused by supply chain disruptions, increases in commodity prices, or labor market shortages. As costs rise, businesses respond by raising their prices, leading to inflation. Cost-push inflation can be controlled by reducing costs or improving productivity.
Cost-Push Inflation: a worked example
An economy starts at short-run equilibrium with a price level index of 100 and real GDP of $900 billion. A drought triples the price of a key agricultural input, raising per-unit production costs across many industries. Short-run aggregate supply shifts left, and the new short-run equilibrium sits at a price level index of 106 with real GDP of $864 billion. The inflation rate is (106 minus 100) divided by 100, times 100, which is 6 percent. The change in real output is (864 minus 900) divided by 900, times 100, which is negative 4 percent. Prices rose 6 percent while output fell 4 percent, the twin symptoms that identify a supply shock. Unemployment rises at the same time, so the economy shows stagflation rather than a normal boom.
The mistake students make with cost-push inflation
On free response questions students draw the aggregate demand curve shifting left when they read the word inflation paired with rising unemployment, because falling output feels like weak demand. That graph is wrong: leftward AD lowers the price level, so it cannot produce inflation at all. Cost-push inflation comes from a leftward shift of short-run aggregate supply, which pushes the price level up and real output down together. Before you draw, check the two directions. Same direction for price and output means an AD shift, opposite directions means an SRAS shift.
Cost-Push Inflation questions
What causes cost-push inflation?
Cost-push inflation starts with anything that raises the per-unit cost of producing output across the whole economy, such as a jump in energy or raw material prices, a rise in nominal wages that outpaces productivity, a new tax on producers, or a disruption that makes inputs scarce. Higher input costs shrink the quantity firms are willing to supply at every price level, shifting short-run aggregate supply left and pushing the price level up while output falls.
Why is cost-push inflation harder for policymakers to fix?
Cost-push inflation forces a trade-off that demand-side policy cannot escape. Contractionary policy that shifts aggregate demand left brings the price level back down but deepens the fall in output and raises unemployment further. Expansionary policy restores output but pushes the price level higher still. Neither tool moves the short-run aggregate supply curve back on its own, so the usual answer is to wait for input costs and nominal wages to adjust, or to pursue supply-side measures that raise productivity.
Is stagflation the same thing as cost-push inflation?
Stagflation names the outcome, cost-push inflation names the cause. Stagflation describes an economy with a rising price level, falling real output, and rising unemployment at the same time, which is exactly the combination a leftward shift in short-run aggregate supply produces. On a Phillips curve diagram the short-run curve shifts up and to the right, so higher inflation and higher unemployment appear together instead of trading off against each other. A demand-side expansion cannot generate that pattern, since it lowers unemployment while raising prices.
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