Question

Suppose a severe drought results in a poor harvest and leads to higher overall food prices. This situation is a _____ shock and is likely to lead to _____ inflation.

Answer 1

Suppose a severe drought results in a poor harvest and leads to higher overall food prices. This situation is a "supply" shock and is likely to lead to "cost-push" inflation.

What is cost-push inflation?

Cost-push inflation happens when a good or service's supply changes but its demand remains the same. Cost push is one of the two causes of inflation. The other is demand-pull inflation.

The causes of cost-push inflation are-

The most frequent causes of it include

• monopolies,
• wage increases,
• natural disasters,
• the introduction of regulations, and
• changes in exchange rates.

In this situation, the supply levels fall down due to loss of harvest and demand remains the same. This will drive up the prices, leading to inflation.

Learn more about inflation, here

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