In case of cost-push inflation :
Supply curve shifts to the left
Cost-push inflation is a leftward shift of the aggregate supply curve — option 3.
The two kinds of inflation. Inflation can begin on either side of the market, and which side it begins on decides both the diagram and the policy response :
| Demand-pull inflation | Cost-push inflation | |
|---|---|---|
| Cause | Aggregate demand rises — more money, higher government spending, easy credit, export boom | Cost of production rises — wages, imported oil, raw materials, indirect taxes |
| Curve that moves | Aggregate demand curve shifts right | Aggregate supply curve shifts left |
| Price level | Rises | Rises |
| Output and employment | Rise | Fall |
| Popular name | “Too much money chasing too few goods” | Stagflation when it persists |
Why the supply curve moves left. The supply curve shows how much firms will produce at each price. If the cost of producing every unit rises, firms will supply less at any given price — or equivalently will require a higher price to supply the same quantity. Either way the whole curve moves to the left, and the new intersection with an unchanged demand curve lies at a higher price and a lower quantity.
Why the distinction matters for policy. Demand-pull inflation can be treated by tightening monetary or fiscal policy, since the problem is excess demand. Cost-push inflation cannot: contracting demand would reduce output and employment further, deepening the recession while doing little about the cost shock. That is the dilemma of stagflation, which is exactly what the industrial economies faced after the oil shocks of 1973 and 1979 — rising prices and falling output at the same time, a combination the simple Phillips curve had said was impossible.
Typical triggers of a cost-push : a jump in crude oil prices, a large negotiated wage increase not matched by productivity, a depreciation of the currency that raises the price of imported inputs, a rise in indirect taxes, or a crop failure that raises food prices.
Hence, the answer is supply curve shifts to the left.
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