Profit-push inflation is when firms use their market power to put up prices, contributing towards inflation. It is a form of cost-push inflation. Profit-push inflation is sometimes known as ‘greed inflation’ and is related to price gouging. Profit push inflation is not the primary cause of inflation, but it can accelerate existing inflationary pressures.
Profit-push inflation explained
Suppose rising oil prices mean the cost of purchasing petrol from oil companies is increasing by 25%. Petrol retailers could just pass all these 25% increase in costs. However, they may also take the opportunity to also make a bigger profit margin and so increase prices by a total of 35%. That is an increase in costs of 25%, and increase in profit margin by 10%.
Why Profit-push inflation
In periods of higher inflation and rapidly rising prices, it is usually easier for firms to increase their profit margins for a few reasons.
- If prices are rising rapidly, consumers will not be able to distinguish the rise due to inflationary pressures and the additional rise in prices from bigger profit margins.
- In periods of inflation, there will be either strong demand and/or rising costs and so consumers will face less alternatives.
- Firms may face menu costs in changing prices. So when prices start to rise, they take the opportunity to make big changes all at once, rather than several small changes. This saves the time and effort of several small changes in price. If inflation had been low in the past, they may have absorbed a smaller profit margin to remain competitive and inflation becomes an opportunity to reverse this.
Impact of profit push inflation
- Profit-push inflation can lead to windfall profits for the companies able to increase their profit margins.
- Exacerbates cost of living problems. Higher prices which lead to more profits will tend to widen income inequality in society. Households will face rising prices, but incomes may struggle to keep up.
- Makes existing inflation problem worse.
Profit-push inflation and market power
If a market is very competitive, then profit push inflation will be much harder to achieve. This is because if a firm seeks to increase its profit margin and set higher prices, then consumers will still have alternatives of buying from other firms who not increasing prices so much.
When a firm has a degree of monopoly power, it is in a much stronger position to increase prices.
The extent of profit push inflation in 2022 inflation
2022 has been a classic example of cost-push inflation. Rising oil and energy prices, have increased the cost of living in the UK, Europe and the United States. Whilst there are clear reasons for cost-push inflation, the increase in prices also has an element of profit push inflation.
A study by IPPR reports that in the UK
“the profits of the largest non-financial companies were up 34 per cent at the end of 2021 compared to pre pandemic levels”
– this shows profit rising faster than inflation, and 90 per cent of the increases in profits is accounted for by only 25 companies.
US profit-push inflation
In the US, “Prices, Profits and Power: An Analysis of 2021 Firm-Level Markups,” by Konczal and Niko Lusiani a paper by stated there were three main causes of US inflation in 2021.
- Covid-related supply shortages
- Surging demand post-Covid
- Profit push inflation, represented in higher profit margins
“Markups and profits skyrocketed in 2021 to their highest recorded level since the 1950s. Further, firms in the US increased their markups and profits in 2021 at the fastest annual pace since 1955.”
Quite a few companies have admitted that rising prices make it easier to increase markups. Many comments on pricing strategies have been noted by the Groundwork Collaborative. As Hostess’s CEO stated
“Pricing, by definition, is a change model. It’s temporary. Consumers get used to it. When all prices go up, it helps.” (audio link)
Limits of Profit-push inflation
It can be easy to be selective in choosing industries where inflation has led to rising profit margins. But, equally, some industries can behave quite differently, where inflation eats into profit margins. As the NY Times notes in an article on Inflation and Price Gouging, in 2021 health care prices rose below inflation, despite being a highly concentrated market.
High inflation can also create substantial uncertainty and lead to falls in the stock market, a sign that companies are not expected to benefit from high inflation in the medium long-term.
Wage-price spiral and profit-push inflation
There is frequently a great fear that in periods of inflation, high wages will cause inflation expectations to rise. Therefore during inflation it is incumbent on workers to show wage restraint, however, whilst workers are expected to show restraint, there is little blame attached to firms increasing profit margins.
Workers may understandably feel that this is a very one-sided look at inflationary pressures. Whilst an inflation-busting pay increase can cause inflation, firms taking advantage of inflation to push up prices further is equally deserving of concern.
Dealing with profit-push inflation
The problem is that in a free market, it is really quite difficult to deal with profit-push inflation.
- Price controls may sound good in theory, but in practice, tend to cause negative unintended consequences.
- Windfall tax on profits. With rapidly rising energy prices, energy companies can make a surge in profits, a windfall tax is a way to redistribute income from a small number of companies to the wider population.
- Increase the competitiveness of markets. The fundamental problem is not so much profit-push inflation, but monopoly power. Where possible, government’s can seek to open markets to more competition. Remove barriers to entry and prevent anti-competitive practices.