Cost-push inflation occurs when production costs rise but demand remains the same, leading to higher retail prices. Wage increases and rising material costs are common causes. This is opposed to demand-pull inflation, which is driven by increased demand for a product. The theory of cost-push inflation is often cited in arguments against minimum wage increases.
Providing a short, clear explanation of economic concepts isn’t always easy, but fortunately the theory of cost-push inflation can be explained in 500 words or less. Economics is largely about comparing different schools of thought, and the leading proponent of the push-cost inflation model is a British economist named John Maynard Keynes. Keynes believed that the health of a country’s economy depended on a mix of public and private controls. Under his economic model, cost-of-payment inflation occurs whenever the cost of production suddenly rises but the demand for the product or service remains the same. This extra cost has to be passed on to the consumer, which in turn increases the retail price.
There are a number of factors that could create high-cost inflation, but the two most obvious causes are wage increases and rising material costs, especially imported goods. The retail price of a product is often based on the current wages of the workers who produce it, so whenever workers receive wage increases, production costs also increase. The company can’t afford to absorb this increase internally, so the additional expense of manufacturing is passed directly on to consumers. Since the consumer’s own wages may not have risen, rising prices are a form of push inflation. The same dollar that could have bought the product last week can now only buy 90% of that product this week. This is what economists would call a lowering of spending power.
Another cause of cut-cost inflation is an increase in the cost of materials or services rendered to the manufacturer. If a foreign economy collapses, the cost of importing materials from that country can rise exponentially. The cost of delivering materials to the manufacturing plant could also rise dramatically during an energy crisis or protracted strike. A manufacturer may decide to absorb some of these additional expenses in order to maintain a competitive price, but not all. The result could be a rise in the retail price and a real-life demonstration of the cost-cutting theory of inflation.
There is also an equal but opposite economic event called demand-pull inflation, which economists other than Keynes tend to argue as the root cause of most consumer price inflation. Unlike pull-pull inflation, pull-on inflation is influenced by the demand for a product, not necessarily the available supply. When gasoline supplies tighten during the holiday season, for example, the price is likely to rise due to increased demand for the product from holiday drivers, not just the ebb and flow of oil production levels. According to the theory of pull-pull inflation, gasoline prices would rise due to higher wages for oil workers or an increase in the price per barrel of unprocessed crude.
The argument against a federal minimum wage increase often includes a reference to cost-based inflation. If workers’ basic wages are increased, producers may feel compelled to pass those increases on to consumers in the form of higher prices. Since an increase in the minimum wage may not benefit workers already receiving higher wages, their spending power may be reduced as a result of such price adjustments. The cost-cutting theory of inflation suggests that this scenario is possible, but historically increasing the federal minimum wage has not resulted in long-term inflation, as other earners may receive increases as well. A rising tide tends to lift all boats.
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