Wednesday, October 9, 2013

12. Inflation - Cost push

One reason given for the phenomenon of inflation is so-called cost-push inflation. In a popular student resource (http://www.tutor2u.net/blog/files/Revision_Causes_of_Inflation.pdf) the following is given as one part of this phenomenon: 1. Component costs: e.g. an increase in the prices of raw materials and components. This might be because of a rise in global commodity prices such as oil, gas copper and agricultural products used in food processing – a good recent example is the surge in the world price of wheat. Companies would ostensibly then respond to rising costs, by increasing their prices of this product to protect profit margins. this is then LABLELLED as Cost-push inflation. Somewhere someone got it wrong - because if businesses increase their prices the consumers will have to pay more for that product. Given a fixed amount of disposable income they will have less available to pay for other products. The demand for the other products will fall and so will the price level for the other products (put in a different way the demand for all other products will shift to the left and prices will fall commensurate to the price rise of this product). The aggregate siuation will however stay exactly the same without ANY rise in price that could be linked to inflation. It is only when there is a similtaneous rise in the money supply that there could be a general rise in the aggregate price level - inflation (cost push) can only be explained in an environment of an increase in money supply. The conclusion that I come to is that cost push is cancelled out by the move to the left in Demand curve in the demand-pull explanation of inflation in a situation where there is a stable money supply. AGGREGATE SUPPLY AND DEMAND STAYS THE SAME IRRESPECTIVE OF THE PRICE LEVELS OF INDIVIDUAL components of the aggregates in a situation of a stable (fixed) money supply. If anyone has a different view, or if I have missed out on something, please let me know.

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