Causes of price changes
Prices in a market economy are not static. They adjust in response to changes in demand and supply. In the short term, price changes can result from natural disasters, shifts in consumer tastes, technological innovations, changes in taxation or sudden changes in income. For example, a poor harvest can reduce the supply of wheat and push up bread prices, while a successful advertising campaign can increase demand for a product and raise its price.
Longer‑term price trends are influenced by broader economic factors such as inflation, productivity growth and exchange rates. Inflation is a sustained rise in the general price level (see Chapter 31); it erodes the purchasing power of money. Deflation is a sustained fall in the general price level. Changes in global commodity prices, exchange rates and government policies can also contribute to rising or falling prices.
Understanding price volatility
Some markets are more volatile than others. Agricultural prices, for instance, fluctuate due to weather conditions and the fact that supply cannot be quickly adjusted. Energy prices can be volatile due to geopolitical events and fluctuations in demand. In such markets, governments sometimes intervene to stabilise prices through buffer stock schemes or subsidies.
By contrast, in markets with stable demand and supply, prices tend to be relatively stable. The degree of competition, the time period considered and the ease of entry for new firms all influence how quickly prices adjust to changes in market conditions.
