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A wage-price spiral that is triggered by weaker competition in the market for goods and services is classified as a type of inflationary supply shock. This shock originates from the supply side of the economy because it directly alters firms' pricing power and their markup over costs, thereby initiating inflation without any preceding change in aggregate demand.

Weaker Competition as a Type of Inflationary Supply Shock

The wage-price spiral is a self-perpetuating cycle of accelerating inflation that occurs when a positive bargaining gap persists, for instance, when employment remains at a level higher than the new supply-side equilibrium following a shock. The process begins when an initial wage increase leads firms to raise prices to protect their profit margins. This price increase erodes workers' real wages, prompting them to demand even higher nominal wages in the next period to compensate for both the new, higher expected inflation and the ongoing bargaining gap. This cycle of wages and prices chasing each other, fueled by continually rising inflation expectations, causes the Phillips curve to shift upward each period, resulting in an ever-increasing rate of inflation.

The Accelerating Wage-Price Spiral

You are an economist analyzing the economic data presented in the case study below. Identify the most likely underlying cause of the rising inflation and explain the economic mechanism at work. Specifically, clarify why this situation is considered a supply-side phenomenon.

Inflation in a Consolidating Market

Explain the economic mechanism through which a decrease in competition among firms can lead to a rise in the overall price level, even when there is no change in aggregate demand. In your explanation, clarify why this is considered a supply-side phenomenon.

Market Structure and Inflation

Explain the complete causal chain through which a decrease in market competition can lead to an increase in the overall price level. In your explanation, clarify why this phenomenon is categorized as a supply-side shock rather than a demand-side one.

The Link Between Market Competition and Inflation

Imagine an economy where a key manufacturing sector undergoes significant consolidation, with many small companies being acquired by a few large corporations. Subsequently, the economy-wide inflation rate begins to rise, despite no significant changes in overall consumer spending, investment, or government policy. Which statement best analyzes the fundamental cause of this new inflationary pressure?

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