Price Stability

Supply Factors affecting Australia's Rate of Inflation

Any factor that causes a decrease in aggregate supply may lead to inflationary pressures in the Australian economy. As such, we can once again use a supply and demand graph to analyse the way in which a change in these factors may affect the rate of inflation.

From this we can see that as aggregate supply shifts to the left (a decrease) the impact is an increase in the general price level. We refer to this type of inflation as cost inflation.

For example, one of the most significant considerations for any business is the price that they must pay for the goods and services that they use in the production of their own final product. We refer to this as the cost of raw materials. When the price paid for raw materials increases, this will have a direct impact on the rate of inflation in Australia.

This is because, in very simple terms, businesses prefer to maintain or increase their profits. To do so in a time of rising costs means that they must “pass on” any increases in costs that they are forced to endure. From a theoretical standpoint, we can say that the increase in costs will mean that suppliers are willing to allocate fewer resources to the production of that item, and therefore supply will decrease. If this is a common trend across the economy, then the impact on aggregate supply may be as seen in the chart above.

Similarly, we can see that when prices fall the supply side pressure on inflation is removed. For example, in 1998/9 the price of inputs actually fell by 0.8%. In the same year, the rate of inflation was very low at 1.1%.

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