Cost Push Inflation

This phenomenon, when restricted to 2-3%, is viewed as a positive pointer of economic growth, as it indicates that there is an increase in the demand and financial stability in an economy. However, too much of it is undesirable and potentially debilitating.

Now there are two main types of inflation - demand pull and cost push inflation. Both these two inflationary tendencies work in tandem to determine the final rate of inflation in an economy. So while a demand pull concerns itself with the demand side of things, a cost push is the type which is necessarily related to rising costs for whatever reasons.

Let's take the most common example. In the 1970s, the OPEC nations decided to create a supply shock, leading to a sudden spike in the prices of oil. Now, oil being an essential commodity in several industries, the increase in the price of oil had an impact on the prices of all the industries which used oil as a raw material, raising their cost of production.

To break even, those industries had to increase their own prices subsequently. This led to an increase in the prices of goods throughout the economy, which was primarily due to the 'pushed up' cost of oil.

The definition states that cost push inflation is a sustained increase in prices, primarily due to an increase in the cost of wages and raw materials. So clearly, rising wages and rising cost of raw materials are two very potent factors which affect it.

When these costs rise, the companies raise the prices of their finished product to protect their profit margins. But then, a lot of items which are end products for one company, are raw materials for another (like oil). Then, with the price of the end product being driven higher, there is an increase in the price of the second product as well.

With increase in wages of employees, they get more purchasing power, which leads them to purchase more goods driving up the demand and therefore, the prices. The other important factor is the fluctuation in exchange rate.

If this fluctuation is not in favor of your home currency, this can drive up the cost of imports and therefore, production. Government imposed taxes too can raise the cost of goods and if the item is an important one, it will raise the prices of all the subsequent goods as well.

Sustained inflation of about 2-3% every year is indicative of a healthy, demand-fueled economy. However, a rate higher than that can prove troublesome.