Question

True or False. If profit and wages are both rising during inflation, the inflation must be a cost-pushed inflation.

Answer 1

True

Cost-push inflation is a phenomenon in which the general price levels rise (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. Because there are fewer goods being produced (supply weakens) and demand for these goods remains consistent, the prices of finished goods increase (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.