March 21, 2018 

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CHANGE IN BUSINESS INVENTORIES: The increase or decrease in the stocks of final goods, intermediate goods, raw materials, and other inputs that businesses keep on hand to use in production. This is one of two main categories of gross private domestic investment included in the National Income and Product Accounts maintained by the Bureau of Economic Analysis. The other category is fixed investment. Change in business inventories is NOT what most people think of when the topic of business investment arises. Inventory changes are considered investment because firms need inventories to smooth the flow of production and sales just like they need factories and equipment to produce goods. In fact, inventories are frequently termed "working capital."

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Inflation of the economy's average price induced by decreases in aggregate supply that result from increases in production cost. This type of inflation occurs when the cost of using any of the four factors of production (labor, capital, land, or entrepreneurship) increases such that aggregate supply cannot satisfy aggregate demand. The alternative type of inflation is demand-pull inflation.
Cost-push inflation places responsibility for inflation squarely on the shoulders of decreases in aggregate supply. In general, higher production cost means the economy simply cannot continue to supply the same production at the same price level. If buyers want the production, they must pay higher prices. The higher cost "pushes" the price level higher.
  • In terms of the production possibilities analysis, this means that the production possibilities frontier is shrinking closer to the origin, causing it to bump down against the aggregate demand. The end result is inflation.

  • In the aggregate market analysis, aggregate supply decreases to less than aggregate demand creating economy-wide shortages. As with any market shortages, the price (price level) rises. The end result is inflation.
While any of the factors of production "could" trigger cost-push inflation, labor and land are the two factors most likely to do so--especially wages and energy prices.
  • In particular, wages paid to labor generally account for about two-thirds of the cost of producing output. Almost any general increase in wages surface as a substantial, economy-wide, increase in production cost. If workers, in total, receive higher wages, then production cost increases, and cost-push inflation is triggered.

  • A similar argument can be made for certain raw material inputs coming from the land, most notably petroleum. Unlike most other materials, petroleum plays an integral role in virtually every good or service produced in the economy, either as a direct material input or as an energy source. Because it is such a pervasive input, any increase in the price of petroleum translates into higher economy-wide production cost, triggering cost-push inflation.

Like demand-pull inflation, cost-push inflation can be sustained only if the economy has more MONEY available. Higher wages or petroleum prices might temporarily cause higher production cost, higher prices, and inflation, but if the buyers do not have the MONEY, then those prices will NOT remain high and inflation will not persist.

If producers cannot pay the higher wages and petroleum prices (because they have no more money), then the resource owners will adjust the prices down. Alternatively, producers might reduce payments to other inputs or factors of production. While higher production cost can trigger cost-push inflation in the short-term, this inflation cannot be sustained without increases in the money supply.


Recommended Citation:

COST-PUSH INFLATION, AmosWEB Encyclonomic WEB*pedia,, AmosWEB LLC, 2000-2018. [Accessed: March 21, 2018].

Check Out These Related Terms...

     | inflation causes | demand-pull inflation | price level | price index | deflation | disinflation | inflation problems | inflation rate | Consumer Price Index | GDP price deflator |

Or For A Little Background...

     | inflation | business cycles | shortage | expansion | macroeconomics | macroeconomic goals | macroeconomic problems | production possibilities | gross domestic product | real gross domestic product | nominal gross domestic product |

And For Further Study...

     | cost of living | Producer Price Index | Wholesale Price Index | CPI and GDP price deflator | unemployment | Bureau of Labor Statistics | Bureau of Economic Analysis | National Income and Product Accounts | circular flow | stabilization policies | production cost | unemployment reasons | aggregate supply decrease, short-run aggregate market | self-correction, aggregate market | wages, aggregate supply determinant | energy prices, aggregate supply determinant |

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