A price level is an average of the prices that apply to an entire range of goods and services. The products will have some sort of relevance or connection to one another, but are not necessarily all the same in structure. The idea is to identify a specific group of goods, look at the various prices that are currently charged for those products and determine what consumers are likely to pay on average for those goods within the current economy.
One of the easiest ways to understand how a price level works is to define a specific set of goods, and determine the average price for those goods. For example, determining the price level for melons at a farmer’s market would involve identifying the prices charged by different vendors for the melons they sell. Once a survey has been taken of what each vendor charges, it is possible to total those amounts, divide by the number of vendors and thus identify the average price level as of that day.
Information of this type if helpful, in that it is possible to compare the level of prices for the current period to previous periods. Using the example of the melons, it may be possible to determine that the average price level increased from one month to the next. While some of the vendors may have maintained their prices, others have increased what they charged for melons, thus causing the price index for the farmer’s market to increase. Consumers benefit by knowing that there has been a general increase or decrease, since the current price level will often influence what they will and will not buy in the short term.
Businesses also benefit from monitoring changes in the price level. Since increases and decreases have a significant effect on the buying habits of consumers, companies must take steps to adjust production accordingly. Here, the idea is to keep up with customer demand, but avoid the situation of having finished goods languishing in storage for extended periods of time. From this perspective, calculating the price level can help a business manage the taxes that apply to business inventories in a more efficient manner, and thus keep general operating costs within reason.
It is also possible to determine a price level for a spectrum of related goods. This approach is sometimes referred to as preparing a basket of goods. In this scenario, a selected number of items are included in the basket, and the total cost for those accumulated items are determined. That level can then be compared to other periods, and determine if there has been a change in the level from one period to the next, or if it remained static.