The best place to start is with terminology. Strictly speaking "bagged tea" is a method of preparation, not a type of tea -- you can put any tea in a bag. Many places sell empty bags for just this purpose.
The term to use is "tea fannings" or in some cases "tea dust". You can brew these sorts of tea without a teabag, if you'd like. You can use a teapot and over-cup mesh strainer, or a mug infuser, for example. You can even look at the example of ceremonial matcha, which is a very fine tea dust, where no attempt is made to separate the dust from the tea whatsoever.
So why would someone choose tea fannings or tea dust instead of whole leaves? One big thing is frequency of consumption, because one of the biggest advantages of whole loose-leaf tea is that it has a very good shelf-life. If the tea takes a month to reach the grocer from the tea farm, is sold in a week, and is consumed by the customers in two weeks, then the appeal of a tea that has a shelf life longer than a few months is not so high. All things being equal a longer shelf-life would be nice, but fannings have a big advantage over loose-leaf, in that the cost of production is lower due to mechanization. So as shipping times became faster (this was the biggest bottleneck), the size of tea particles became smaller in places like Ireland and the UK which used to be very heavy tea-drinkers. These sorts of teas are also easier to blend with, because there is no obvious distinction between the leaves of one garden and another, which can stabilize the price season to season.
Part of this was possible because of strong supply-chain control. One reason tea-fannings have never been as popular in China is because the Chinese market is full of counterfeits, and all tea fannings look the same, allowing malicious blending of teas from different regions, among other things. In the UK, the plantations were vertically integrated with the wholesalers, and sometimes also the retailers, so much of the tea never exchanged hands at all, which shaped how the rest of the market acted.
I think the problem comes when for whatever reason people start drinking less tea. Now the stock is not as fresh, more likely to become stale before it is finished. Reverting to a larger size would be much harder because now the price goes up. These larger sizes can't be used in blends with fannings or dusts because it causes mixed grade problems. So now all of the suppliers need to change to a larger size. Teabag shapes would need to be re-tooled. Habitual tea-drinkers are stressed by any change in their usual teas. So I suspect that instead what happens is that the sellers reformulate their blends to lower the price, in hopes that this will boost the demand back above the freshness threshold. Tea-grocers come out with new advertising campaigns. But of course this just makes the problem worse.
My pet theory, anyway.
(i'm based in the south of the UK)
at work burgh) 
