Cost push inflation or cost inflation is induced by the wage-inflation process. Cost-push inflation occurs when the price of inputs increases. Businesses must acquire raw materials, labour, energy, and capital to operate.
This is especially true for a Country like India, where labour intensive techniques are commonly used. Theories of cost-push inflation (also called sellers’ or mark-up inflation) came to be put forward after the mid-1950s.They appeared largely in refutation of the demand-pull theories of inflation and three important common ingredients of such theories are
- That the upward push in costs is autonomous of the demand conditions in the concerned market
- That the push forces operate through some important cost component such as wages, profits (mark up), or materials cost.
Accordingly, cost-push inflation can have the forms of wage-push inflation, profit-push inflation, material-cost push inflation, or inflation of a mixed variety in which several push factors reinforce each other and that the increase in costs is passed on to buyers of goods in the form of higher prices, and not absorbed by producers. Thus, a rise in wages leads to a rise in the total cost of production and a consequent rise in the price level, because fundamentally, prices are based on costs. It has been said that a rise in wages causing arise in prices may, in turn, generate an inflationary spiral because an increase would motivate the workers to demand more wages.
Cost-push inflation can be diagrammatically explained as follows.
In the above figure, demand curve D represent the aggregate demand function and SS represents aggregate supply function. The full employment level of income is OY. At this F is the point of intersection between aggregate demand and aggregate supply function. When aggregate supply function shifts upward to S1 it will become a vertical straight line at point G at full employment level. The new equilibrium point A is determined at OY1 level of output, which is less than full employment level at P1 level of prices. This means that with a rise in the price level unemployment increases. A further shift in the aggregate supply curve to S2 due to further increase in wages lead to further increase in price to P2 and fall in income level to OY2