The price level is the average level of all prices for goods and services in an economy and is expressed as an index number. In theory, the price level is the price of aggregate production and it is measured by the consumer price index (CPI) or the GDP price deflator. The inflation rate is calculated as the percentage change in price level¹. Price level is a key part in macroeconomic analysis and was originally designed to understand inflation.
To measure price level, a price index is calculated, averaging the prices of various products by how valued they are by consumers. In Canada, the consumer price index (CPI) measures the price of goods and services bought in a typical Canadian household. Price level is measured as an index number so its value at a specific time is only relevant when compared with its value at another time. So, to summarize, the price index, such as the CPI, lets us compare price level at different times and will allow us to measure the rate of inflation.
Price level functions similarly in an aggregate market as it does in a standard market. The aggregate demand (AD) curve shows the relation between price level and amount of real GDP demanded by household, business, government, and foreign sectors.
The aggregate supply curves show the short-run and long-run relation to price level and amount of GDP in a macro economy. When an aggregate market is presented on a graph, the price level (measured by the GDP price deflator) is on the vertical axis and real GDP is one the horizontal axis.
1. PRICE LEVEL, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2014. [Accessed: January 7, 2014].