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Sep '10 Q24 - Causes of Cost Push Inflation

M

maz1987

Member
Which one of the following is NOT a cause of cost push inflation?

A An increase in the price of raw materials.
B A percentage increase in wages which is less than the percentage increase in labour productivity.
C An increase in the profit margins applied by firms.
D A depreciation of the exchange rate.

I figured B was the answer, since an increase in wages means demand increases, which is a cause of demand-pull inflation. Is this correct?

However, I would have thought that nor was C a cause of cost-push inflation. An increase in profit margins may mean wages decrease, which means demand will decrease, and clearly isn't a cause of cost-push inflation.

Thanks
 
I don't think demand comes into it at all in this question (and I'm a bit confused with your demand-related arguments!).

I don't think B is a cause of inflation at all. If wages increase by less than the increase in productivity, then that's effectively a fall in costs to firms (imagine if you got a 50% pay rise, but that your productivity increased by 100% - your employer would be winning and would consider you to be cheaper than before) :)

According to the textbook (P581 and 588), cost-push inflation may be due to increases in wages, profits or imports. In each case, the increase effectively increases the cost to the producer and shifts the supply curve to the left. Profit may be thought of as a cost because if the profit margin increases then firms will charge more for the good (and the demand curve will be unaffected, although we will move along it).

In terms of your demand-related arguments, I would say that an increase in wages (ie an increase in the price of labour) would NOT increase the demand for labour; rather it would lead to a leftward movement ALONG the labour demand curve (which corresponds to a decrease in quantity demanded). And similarly, a decrease in wages would lead to a rightward movement ALONG the labour demand curve (which corresponds to an increase in quantity demanded)...
 
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