AP Syllabus focus: ‘Cost-push inflation occurs when falling short-run aggregate supply raises the price level and lowers output.’
Cost-push inflation explains why economies can face rising inflation at the same time as falling real GDP. In the AD–AS model, it is driven by adverse production conditions that shift short-run aggregate supply (SRAS) left.
Core idea: inflation from the supply side
Cost-push inflation: A sustained rise in the price level caused by a decrease in short-run aggregate supply, which raises firms’ per-unit production costs and reduces real output in the short run.
Cost-push inflation is a negative SRAS shock: firms are willing and able to produce less at every price level because costs have risen or productivity has fallen. This differs from inflation generated by increases in spending; here, the main force is worsening production conditions.
How to show cost-push inflation in the AD–AS model
The SRAS shift and the new short-run equilibrium
In the AD–AS diagram:
Start at an initial equilibrium where AD intersects SRAS.
A negative supply shock shifts SRAS left (from SRAS₁ to SRAS₂).
With AD unchanged, the new intersection implies:
Higher price level (inflation)
Lower real GDP (contraction)
Lower employment and higher unemployment (because output falls)
Why the price level rises while output falls
When production becomes more expensive, firms require higher output prices to supply the same quantity. If the overall price level does not rise, output is cut back, so real GDP falls. The economy experiences a combination often described as stagflation (stagnant output with inflation), which is a key implication of cost-push inflation.
This diagram shows a leftward SRAS shift (a negative supply shock) with AD held constant and LRAS marking full-employment output. The new short-run equilibrium features a higher price level (PL1 to PL2) and a lower level of real GDP (Y1 to Y2), which is the classic stagflation outcome. Because the curves and endpoints are explicitly labeled, it is well-suited for FRQ-style explanations. Source
Stagflation: A macroeconomic situation in which inflation rises while real output falls (and unemployment rises), commonly associated with a leftward shift of SRAS.
Common sources of a fall in SRAS (cost shocks)
Rising input prices
Cost-push inflation often begins with higher costs of production, such as:
Energy or commodity price spikes (e.g., oil)
Higher imported input costs (especially when a country relies on foreign components)
A broad increase in wages not matched by productivity growth
Negative productivity or supply disruptions
Even if input prices do not rise, SRAS can fall when output per unit of input declines:
Supply-chain disruptions that reduce effective productive capacity
Natural disasters that interrupt production networks
Sudden equipment shortages that lower throughput
Policy and institutional factors that raise per-unit costs
Some changes increase firms’ costs economy-wide:
New compliance requirements that raise marginal costs
Reduced market competition that raises costs or lowers efficiency
Currency depreciation that raises the domestic cost of imported inputs (the key channel is higher production costs rather than stronger demand)
What to remember about unemployment and output
Cost-push inflation is associated with lower real GDP relative to what would otherwise occur. When firms cut production:
Fewer workers are needed, so employment falls.
Unemployment rises in the short run as layoffs increase and vacancies decline.
The economy can face a policy trade-off: reducing inflation may further reduce output, while supporting output may worsen inflation.
Identifying cost-push inflation in real-world data (conceptually)
Patterns consistent with cost-push inflation include:
This infographic summarizes the Phillips-curve idea by plotting unemployment on the horizontal axis and wage inflation on the vertical axis. It visually reinforces that inflation and unemployment are key variables to look for in macro data when diagnosing stagflation-like patterns. While it is not an SRAS-shift diagram, it complements your data-identification section by emphasizing the inflation–unemployment connection. Source
Inflation rising alongside slowing or negative real GDP growth
Worsening labour-market conditions (rising unemployment or falling hours worked)
Evidence of rising unit costs (e.g., energy, shipping, key intermediate goods) or declining productivity
FAQ
Persistence can come from repeated shocks, wage renegotiations, or firms rebuilding margins.
If expectations adapt, price- and wage-setting may “bake in” higher inflation even after the initial disruption fades.
If firms and workers expect higher inflation, they may set higher prices and wages sooner.
That can amplify the leftward SRAS shift by raising unit labour costs more rapidly.
Vulnerability rises with energy intensity and import dependence.
Key factors include:
Limited domestic energy supply
High transport costs in production
Few short-run substitutes for energy inputs
Indexation automatically raises wages when prices rise, which can increase costs again.
This can create a feedback loop that sustains inflation even when demand is weak.
They look for broad-based and sustained increases across many categories, not just a narrow spike.
Measures like trimmed-mean or median inflation can help judge whether inflation is widespread.
Practice Questions
(2 marks) Using the AD–AS model, state what happens to the price level and real GDP when SRAS decreases.
Price level rises (1)
Real GDP falls (1)
(6 marks) Explain how a rise in economy-wide production costs can generate cost-push inflation, and describe the resulting changes in real GDP and unemployment in the short run.
Identifies that higher production costs reduce SRAS / shift SRAS left (1)
Explains that with AD unchanged, the equilibrium price level increases (inflation) (1)
Explains that equilibrium real GDP decreases (1)
Links lower output to lower labour demand (1)
States unemployment rises in the short run (1)
Uses correct AD–AS reasoning/terminology consistently (1)
