What is Price Level?
Definition: Price level denotes the cost of goods and services in an economy. It is the average of all prices of an entire spectrum of products and services. Economists pay close watch to price level as it helps shed more light on consumers’ purchasing power. The analysis also helps in the determination of the supply-demand chain.
Understanding Price Level Examples
In its purest form, price level refers to the price at which consumers in a market are in agreement, a good or service should go for. The level, in this case, tends to fluctuate in response to changes in demand and supply. An increase in demand as supply falls or remains the same can cause the price level to rise significantly. Similarly, an increase in supply relative to demand can trigger a substantial decline in the price level.
Price level is, therefore, an important component in the determination of inflation levels in an economy. A significant rise in prices over a short period of time is many, at times, attributed to a spike in inflation levels. Such a move can cause the central bank to step in and deliver policies that would curtail further spikes.
The price level can also be used to denote the prices of assets as traded in the capital markets. In the capital markets, price level refers to the prices of securities as traded on the market. Likewise, prices levels for stocks and commodities fluctuates as buyers and sellers battle it out.
Factors that Influence Price Level
Prices and quantities are some of the main factors that influence price levels in an economy. An increase in the price level of an item may be as a result of an increase in prices of similar products in the market. Likewise, changes in supply go a long way in affecting price. For instance, an increase in supply may result in a surplus, forcing producers to drop price in a bid to attract more buyers.
Sellers also influence prices in one way or another. A seller dealing in high-quality products would often hike prices if demand in the market is high. Similarly, a seller controlling substantial market share would alter prices with little opposition from other sellers in the market. Likewise a seller just getting started may offer low price levels, in a bid to attract customers, a move that creates competition, consequently forcing other sellers to respond adequately.
Producers also have a significant impact on the prevailing price levels in the market. For most common consumers, product prices are determined at the production stage and later influenced by distribution channels. The fact that every person handling good from production until it finds its way to consumers must make a profit, tends to have a significant impact on price levels.
Price Level Impact on Other Variables
Price level is one of the key drivers of inflation in any economy. An increase in price levels of various products at times triggers high levels of inflation in the overall economy. Similarly, a decline in prices leads to a decline in inflation.
An increase in price levels without a corresponding increase in consumer wages many at times leads to a sticky situation in the economy. Such a situation can take a significant toll on the consumer’s purchasing power. In return, consumers may struggle to buy some Items leading to a surplus in the market. Price levels also decreases the purchasing power for real money.
Summary
Price level is one of the most-watched economic indicators as it sheds more light on consumers’ purchasing power. In its purest form, it is the price at which consumers are willing to buy goods and services. Likewise, price levels should remain stable if an economy is to stay clear of the undue effects of inflation and deflation.