Practice Exam Questions
Wages and Cost Push Inflation – Chain of Reasoning
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Last updated 24 Nov 2022
In this revision video we work through an example of a chain of reasoning to the question: Analyse how increasing wages can cause cost-push inflation.
Labour costs are often the highest cost for a business. This is true in labour-intensive industries.
An increase in hourly wage rates in an industry such as construction can lead to higher unit labour costs
As a result, firms are then under pressure to raise their prices to protect their profit margins
Higher unit labour costs therefore cause an inward shift of short run aggregate supply (SRAS)
Ceteris paribus, this will lead to an increase in cost-push inflation
With prices rising, workers may then demand compensating wage increases to protect real incomes
- Whether or not higher wages cause cost-push inflation depends in part on what is happening to labour productivity. For example, if wages are increasing by 3% and labour efficiency (output per worker) also grows by 3%, then unit labour costs will remain the same.
- Other costs such as global energy prices or prices for essential raw materials and components might be falling.