What Causes Increases in Price Level?

Increases in price level are also referred to as inflation. Such price increases in an economy are usually due to the effect of macroeconomic factors like demand, supply and consumption. All other macroeconomic factors that affect increases in price level are somehow related to these three factors. Those other areas include interest rate, monetary policies and Gross Domestic Product (GDP).

Demand and supply cause increases in price level due to the fact that the level of demand in an economy plays a role in determining the activity level of the market. A consistent and active market in which the level of supply is approximately equal to the level of demand is desirable, because the price of goods and services remain stable, barring any other extraneous factor. When the demand is more than the supply, the natural consequence is an increase in the price of goods and services. Such an increase may be due to a number of factors that include hoarding of goods in anticipation of fear or scarcity, and the fact that scarce resources become more precious as a result of the unavailability.

Another factor that causes increases in price level is the deliberate action of manufacturers, producers and retailers of goods and services who may artificially increase the price of products in order to maximize profits or to make up for an imbalance in cash inflow. This type of action contributes to inflationary effects on the economy by causing the prices of goods and services to go up to a level that is higher than normal. Sometimes the companies may bring the price of the goods down after a while, or the new price regime may remain.

Too much or excess liquid cash in the market place is a factor that results in increases in price levels as well. This is especially true when the cash in the economy is more readily available than the goods or services. This type of situation may occur in some economies where the government engages in the indiscriminate printing of money as an answer to financial shortfalls. The money soon loses its value and results in a situation where a suitcase full of money will only purchase a handful of goods when the opposite used to be true.

Employee activities are indirectly related to increases in price level, because during an inflation workers find that their salaries no longer go as far as before. This may prompt employees and various labor unions to agitate for increases in salaries so that the money will catch up with the increases in the price of goods and services. In some economies, this causes a further shift in the price of goods and services as merchants further increase the prices of goods in response to the increase in salary.