“Cost-push inflation is result of increase in Factor of Production cost.”
As we read under heading factor of production, these factors have some income, rent for land, wage for labor etc. Assume there is demand for more income by laborers.
Wait a minute! Why will labor demand more income suddenly & for no reason ?
There is a big reason. Labor are finding it hard to purchase essential commodities & trying hard to keep their neck above water. Due to high prices in market, labor is demanding more wage.**
If you’re owner of some land and you rented same to one entrepreneur. With time taking toll and inflation going high. Will you keep the rent same for years ? The answer is no. Rent also increase with time. And. If entrepreneur pays more rent, will she not add the extra rent cost to the products being manufactured. Thus higher production cost bring down supply numbers. This weak supply with consistent demand bring inflation in products price due to a mismatch.
This theory is not well accepted among all economist.
Let us read it again:
Factor input price goes up, Production cost goes up, Supply weakens, Demand remains same!
If supply weakens, that means Whatever is being supplied, will be sold at higher cost. If still people continue to buy and do not cut consumption, there is extra purchasing power in people hand.
What is this extra purchasing power ?
If govt policies direct at more spending in economy, or Central bank gives cheap loan to banks, or your employer is giving you more salary because she is able to take benefit of cheap loans and govt policies. This means more money is there in economy. Till the economic activity doesn’t catch up with this higher level of money. There will be a gap (Inflationary Gap). The gap results in inflation.***
** When labor will get more wage, their demand in market will increase. (As happened in MGNREGA) When demand will increase, products price will increase. Products price rise will again make labors to demand more wage. This repeated sequence is known as wage-price spiral or inflationary spiral. Please do not mix this topic with cost-push inflation.
*** Discussed in separate topic Inflationary Gap.
Note: Increased demand is seen as good for growth of economy. As it bring more employment, more economic activity, increased remuneration etc. Stagnant demand and low demand are always matter of concern. It is synonymous with depression or recession.