The aggregate price level refers to the general or aggregate price of the collective goods and services produced in an economy over a period of time. The calculation of this price is determined by various economic factors, including aspects like the effects of excessive demand and the effects of excessive supply. Economists rely on this number as a means of making determinations regarding the macroeconomic status of the economy of a nation.
When the aggregate demand price level is relatively steady over a period of time, this indicates to interested observers that the demand and supply are at a relatively desirable level within the economy. Indicators of changes in this level include factors like deflation and inflation, with their accompanying effects on the economy. A noticeable shift in either direction may lead to the introduction of mitigating macroeconomic factors meant to correct the imbalance, such as monetary policies that may be introduced by the central bank of an economy and fiscal policies that may be introduced by the government.
A drop in the aggregate price level, also known as a deflation, is normally the result of too little demand by consumers for the finished products in an economy. When the consumers fail to buy as much product as before, the aggregate price of the products will drop in response to the sluggishness of the market. In such a situation, a central bank may try to artificially stimulate the market through manipulating the interest rate. A reduction of the interest rate may encourage the consumers to obtain more money from banks and to spend more. The consequence of increased demand for products and spending for consumers will be a rise in prices.
An increase in the price level, or inflation, is usually due to an excessive demand for goods and services that may be more than the economy can sustain. When this type of activity starts to overheat the market, it is reflected in rising prices. The central bank may increase the interest rate levels as one of the possible measures for putting a halt to, or minimizing, the spending and demand that is pushing the general price of goods and services upward.