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What Is the Connection between Price Level and Inflation?

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  • Written By: Esther Ejim
  • Edited By: Kaci Lane Hindman
  • Last Modified Date: 29 November 2016
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The relationship between price level and inflation is the fact that price level can be used as a tool for the assessment of the state of the economy with a view to finding out the if the prices are remaining steady, decreasing or inflating. The price level gives economists an idea of the aggregate price of commodities on the market within the particular period under consideration. This examination of the price level may be done at regular scheduled intervals with a view to comparing the results and finding out if the prices of the goods and services are maintaining a steady position or if the prices are rising.

When economists compare the price levels from several periods and discover that it is rising instead of maintaining a desired balance, this will indicate to them that the increased demand for goods and services are pushing the prices up as well. The link between price level and inflation also allows economists and various governments to predict when a recession is likely to occur in the future. This is due to the fact that when the market is overheated from excessive demand for limited goods and services, it pushes up the Gross Domestic Product (GDP) as well as the prices of commodities.

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Such a situation results in a period of economic boom that the economy simply cannot sustain. Study of business cycles have indicated that a boom in the economy accomplished by periods of fevered activity on the market usually results in a crash as the economy implodes on itself due to the unsustainability of such high levels of activity. The government takes this relationship between price level and inflation very seriously, which is why it will try to take necessary measures to prevent a recession by introducing procedures intended to bring down the price level.

One of those methods includes the reduction in the amount of money that is available on the market. It may also utilize one method that various governments rely on to reduce the price level in the economy, which is the increase of interest rates. The link between price level and inflation may also be seen in the way in which a reduction in aggregate price level leads to the avoidance of a perceived imminent recession. If the government is able to curtail consumer demand and spending on goods and services, it will help bring the price level down and help prevent a recession.

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