What Causes Decreases in Price Level?

Decreases in price level in an economy may be attributed to various factors. The factors that lead to the price level decreasing is an increase of the interest rate by a nation’s central government, competition among manufacturers, a reduction or scarcity of the available cash in the market, and an improvement in the efficiency of manufacturers. A common term used for decreases in price level is deflation.

When the government or central bank in a country notices a rise in the aggregate price of goods caused by excessive demand, it may try to mitigate the price increase by raising interest rates. The act of raising the interest rates makes it more expensive for consumers to borrow money from banks for various purchases. It also makes the banks less willing to lend money to consumers on terms that the consumers might be willing to accept. Banks also encourage various customers to save more money by increasing the interest rates on savings accounts. These actions cause a drop in the level of demand for goods, leading to decreases in price level.

Competition among various manufacturers and producers of consumables may lead to decreases in price level. When there is a lot of competition among such manufacturers, one of the tactics they resort to is the slashing of the prices of goods and services as part of their marketing strategy to entice customers to trade with them instead of other producers of similar goods. This reduction in prices is reflected in a reduction of aggregate or general prices of goods in the economy.

Manufacturers may also affect the economy by causing decreases in price level through developing better techniques for production and improving techniques to minimize waste. The improved efficiency may lead to a reduction in the number of employees and the introduction of other cost-saving methods. Examples of this include the use of automated answering services and the use of mechanical assembly lines in huge manufacturing plants. The savings are passed on to the various customers through reduced prices and are also translated to general decreases in price level.

Sometimes, the central bank or government may engage in the mopping up of surplus cash in the market and also in the restriction of money being printed in an effort to cause decreases in general price levels. Excess cash in the economy is partly responsible for inflation, because when cash is surplus it starts to lose its value. When the cash is restricted however, the value will increase and a little cash will go further than when there is too much in the market.