The price level of a country is the weighted average of the price of its goods and services. The weights used are usually related to the relative importance of each good or service in people’s consumption or national production.
The price level reflects the average value of the goods and services of an economy at a given moment in time.
Its calculation formula is as follows:
NP = price level in the period
Pi = Prices of goods and services (i: 1… n)
a, b,… = weights
n = number of goods and services included in the calculation.
Price level example
Suppose an economy has only two goods, A and B. Their respective prices are 100 and 500. The price level is then at: (100 + 500) / 2 = 300.
Now suppose that the prices of A and B the following semester change to 150 and 600. The price level will be 375. Then, it can be said that the price level has increased.
In the previous calculation the weights used were equal to 1. It is also possible to calculate a weighted average using different weights for each good or service.
Price level variation
The variation in the price level seeks to reflect the change in the cost of living of citizens. When the price level increases over a period of time, inflation is said to exist , when it falls, deflation .
Relationship between price level and a price index
The price index reflects the movement of the general price level between two time periods (daily, monthly, etc.). It is calculated as the ratio or quotient between two price levels and is usually expressed in percentage terms. The main price indices are the GDP deflator and the CPI .
It is worth mentioning that the information to build the price index must be updated from time to time because consumer behavior and the supply of goods and services may change over time. For example, today internet consumption (broadband or other medium) is massive and is an important element in the representative consumer basket. This did not happen 15 years ago, where the internet was little known and almost a luxury.