Cost inflation

Cost inflation or supply inflation appears when restrictions are imposed on the supply of one or several resources, or when the price of one or several stocks is increased. The cost inflation may result from the increase in each of the cost components, assuming that the remaining ones do not change.

Causes of cost inflation

• increase in wages,
• increase in raw material prices,
• increase in prices of imported products,
• increase in prices of raw materials and imported intermediates,
• increase in prices of raw materials and semi-products of domestic origin,
• an increase in surcharges on wages (e.g. social security contributions),
• increase in other cost components (e.g. increase in the cost of interest on bank loans, increase in lease costs).

Examples of cost inflation

The factors of cost inflation occur on the supply side. For example, inflation pushed by costs can be caused by cutting off oil supplies from imports in the event of war or political unrest. Competing for limited supply then influences the rise in oil prices. Another example of its creation may be a reduction in food supplies, for example cereals due to crop failure. It may also result from a rise in wages which is not accompanied by a simultaneous increase in labor productivity or results from price fixing by monopolies and oligopolies. On the supply side, there are monopolists on the markets of goods and services and the labor market who decide on the level of prices and wages. Therefore, the government, which aims to ensure full employment, will increase the wages of employees (which is the price of a job service). On the other hand, from the part of employers, to the increase in prices of manufactured products. Many factors may influence the increase in production costs, therefore the emergence and development of inflation processes. These differences arise as a result of changes in the conditions of the supply of goods. Then production is limited either physically or because higher prices reduce the demand for a given good. Competition between consumers results in a general price increase. The cost inflation is cumulative, thanks to the "price and wage spiral". The basic cost factor that stimulates inflation in the economy is wages. However, it is a very one-sided approach to the causes of inflation, which does not take into account other factors initiating and creating inflation processes. For example, increase in supply or increase in money demand. However, this statement does not negate the occurrence of these factors in the inflation mechanism.

Variations of cost inflation

• wage inflation
• import inflation
• exogenous (external) inflation
• endogenous (internal) inflation

The wage inflation formulated by JK Galbraith speaks of the strength of trade unions, that they implement their own wage policy regardless of the situation existing on the labor market. This is evidenced, inter alia, by the persistence of a high level of wages, even when there is high unemployment. Forcing unnecessary wage demands by trade unions results in an increase in production costs, which in turn leads to a rise in prices, and thus to the spiraling: increase in wages - a rise in prices. Also vice versa - the increase in prices results in demands for wage increases on the part of employees, so that their standard of living does not deteriorate, thus there is a spiral: a rise in prices - an increase in wages. Wage demands of strong trade unions may also result in demands for a rise in other industries, regardless of the dynamics of labor productivity.

Import inflation, on the other hand, is caused by the rise in prices abroad. Then, when the price of goods imported from abroad increases, domestic prices also increase. The reason is the increase in prices necessary for production, raw materials and imported intermediates. An example is the sharp rise in oil prices, which caused a rise in gasoline prices and transport costs as well as an increase in product prices in industries for which crude oil was a raw material for further production. The influence of the increase in the prices of imported goods on the development of inflation is all the greater, the greater the share of foreign trade in the economy.

Exogenous cost movements can arise as a result of specific disturbances in the economy that are independent or dependent. An example of such non-economic disturbances may be an increase in the prices of imported goods and war. Within the economy, a decline in labor productivity and crop failures.

The endogenous type is associated with the existence of strong socio-economic groups in the economy (e.g. monopolistic producers, trade unions, consumer organizations) that are able to influence the level of income they earn (profits, wages, etc.). Through competition for more favorable relations of the remuneration of production factors, the income of individual groups grow at a different pace with each other and the dynamics of national income. As a result, their nominal dynamics exceeds the production dynamics, which contributes to the realignment of income by inflationary price increase.

Anti-inflation policy

In this case, it is advisable to reduce the rate of increase in costs. This can be achieved by weakening the monopolistic impact on prices and wages and by stimulating labor productivity that decreases unit production costs. Therefore, the anti-inflation policy should improve the institutional conditions that determine how to generate income growth.

Cost inflation — recommended articles

Economic situation — Structural inflation — Price control — Inflation import — Natural rate of unemployment — Demand shock — Factors affecting supply — Price risk — David Ricardo

References

• Banerjee, A., & Russell, B. (2005). Inflation and measures of the markup. Journal of Macroeconomics, 27(2), 289-306.
• Attanasio, O. P., Guiso, L., & Jappelli, T. (2002). The demand for money, financial innovation, and the welfare cost of inflation: An analysis with household data. Journal of Political Economy, 110(2), 317-351.
• Chowdhury, I., Hoffmann, M., & Schabert, A. (2006). Inflation dynamics and the cost channel of monetary transmission. European Economic Review, 50(4), 995-1016.