Price level

The classical dichotomy is the assumption that there is a relatively clean distinction between overall increases or decreases in prices and underlying, “nominal” economic variables. Thus, if prices overall increase or decrease, it is assumed that this change can be decomposed as follows:

Given a set ${\displaystyle C}$ of goods and services, the total value of transactions in ${\displaystyle C}$ at time ${\displaystyle t}$ is

${\displaystyle \sum _{c\,\in \,C}(p_{c,t}\cdot q_{c,t})=\sum _{c\,\in \,C}[(P_{t}\cdot p'_{c,t})\cdot q_{c,t}]=P_{t}\cdot \sum _{c\,\in \,C}(p'_{c,t}\cdot q_{c,t})}$

where

${\displaystyle q_{c,t}\,}$ represents the quantity of ${\displaystyle c}$ at time ${\displaystyle t}$

${\displaystyle p_{c,t}\,}$ represents the prevailing price of ${\displaystyle c}$ at time ${\displaystyle t}$

${\displaystyle p'_{c,t}}$ represents the “real” price of ${\displaystyle c}$ at time ${\displaystyle t}$

${\displaystyle P_{t}}$ is the price level at time ${\displaystyle t}$

The general price level is distinguished from a price index in that the existence of the former depends upon the classical dichotomy, while the latter is simply a computation, and many such will be possible regardless of whether they are meaningful.

If, indeed, a general price level component could be distinguished, then it would be possible to measure the difference in overall prices between two regions or intervals. For example, the inflation rate could be measured as

${\displaystyle {\frac {(P_{t_{1}}-P_{t_{0}})/P_{t_{0}}}{t_{1}-t_{0}}}}$

and “real” economic growth or contraction could be distinguished from mere price changes by deflating GDP or some other measure.

${\displaystyle {\frac {(GDP)_{t_{1}}}{P_{t_{1}}}}-{\frac {(GDP)_{t_{0}}}{P_{t_{0}}}}}$

Applicable indices are the consumer price index (CPI), Default Price Deflator, and the Producer Price Index.

Price indices not only affect the rate of inflation, but are also part of real output and productivity.[1]

• Price index
• Equation of exchange
• Quantity theory of money
• Wage level

• McCulloch, James Huston (1 January 1982). Money and Inflation: A Monetarist Approach. Academic Press. ISBN 978-0-12-483051-6.
• Mises, Ludwig Heinrich Edler von; Human Action: A Treatise on Economics (1949), Ch. XVII “Indirect Exchange”, §4. “The Determination of the Purchasing Power of Money”.