Question

Cost-push inflation occurs in the presence of __________________.

1. excess inventory

2. a trade deficit

3. rising per-unit production costs

4. excess demand for goods and services

Short answer

Option (c): rising per-unit production costs

Step-by-step solution

Explanation for the correct option

The cost-push inflation results from the increasing cost of inputs/factors of production.Increasing cost forces the firms to increase the prices of goods and services to maintain the difference between revenue and cost, even though they do not wish to.

If per-unit production costs (average costs) rise, the firms’ profits start diminishing if the prices remain the same. This reduces the output at prevailing prices. As the output declines, the price level goes up.

Explanation for the incorrect options

Excess inventory means hoarding raw materials and finished goods to meet unexpected increases in demand in the future.This also creates an artificial shortage in the market to earn higher profits by rising prices. However, this can happen only with a few goods and that too for only a short period.

A trade deficit means an excess of imports over exports.The trade deficit occurs if the imports are cheaper than exports (or appreciation of the domestic currency). This should not increase the costs of domestically produced goods or result in cost-push inflation.

When demand for goods and services exceeds the supply, it creates demand-pull inflation.