ATAR Survival Guide

Cost push inflation is where the aggregate supply of an economy has decreased shown from the movement in the aggregate supply curve from AS1 to AS2. 

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Sources of a decrease in aggregate supply could be from:

• Lower productivity levels

• Rise in anti-competitive behaviour (eg formation of cartels or price fixing)

• Protectionist measures which will increasing the cost of inputs

• Increase in wages (eg from a higher minimum wage or inefficient labour economic policies)

• Inefficient investment in infrastructure causing bottlenecks and shortages

• Higher levels of tax and complexity of taxation - which could increase cost of production and lower future investment

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This position is not ideal in the economy as it results in:

• Higher price levels - conflicts with objective of price stability

• Lower economic growth - conflicts with objective of sustainable economic growth

• Higher cyclical unemployment (from lower economic growth) - conflicts with the objective of full employment

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In addition, Government policy options are also limited: 

• RBA could increase cash rate to reduce inflationary pressure but this will lower real GDP further

• Government could impose a larger deficit to increase economic growth but this will also stimulate further increases in price level

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An appropriate Government policy response would be to increase aggregate supply through microeconomic reform and promoting productivity. (More details in productivity section)

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Increase in Aggregate Supply