Changes in price level in an economy are usually the result of various factors like changes in demand or supply, monetary policies, fiscal policies, or the actions of producers and manufacturers of goods and services. The most direct and important influence on the changes in supply level is caused by a change in demand for goods and services. Any change in the supply of goods and services that is artificially manipulated by manufacturers also influences the price level in an economy.
Demand and supply cause changes in price level in the sense that the prices of goods and services almost always go up when the demand for such items outweighs the supply. Such a situation may also be referred to as inflation. A steady price is dependent on a steady rate of demand and supply. When one of these factors is skewed in one direction or the other, this often results in either inflation or a deflation. The rise in price is often due to the fact that high demand for products usually drives up the prices of products.
When there is a surplus of goods in the market and too little demand for the goods, the result is a deflation. A deflation means that there is a decrease in the price level of aggregate products. Sometimes a deflation is not the consequence of a surplus of goods in the market, but rather it is the consequence of the actions by a central bank of a country or by a government. When a central bank or government perceives that there is inflation in the economy as a consequence of changes in price level, the next step will be to introduce monetary or fiscal policies to address the imbalance.
One method by which the central bank of a country can affect the general price levels is to increase the interest rate. Increasing the interest rate is a measure aimed at reducing the demand for goods and services, consequently leading to a reduction in the aggregate price. This measure is usually utilized in the wake of inflation in the economy. Another way in which interest rates can cause changes in price level is to cause an increase in the demand for goods and services. This usually happens when the central bank reduces the interest rates.
Manufacturers can affect changes in price level through their actions as well. When producers of goods and services perceive that they are not meeting their targets in terms of sales, one of the methods they might utilize to increase profits is to increase the prices of goods and services. Such an action also pushes up the aggregate price of goods in the economy.