Price level

The price level () specifies how many units of a currency to be paid for a unit of the national product. The reciprocal price level indicates the purchasing power of a currency. To this end, the prices of goods of a shopping cart on a price index can be measured.

Increases the price level in the economy, purchasing power decreases (and vice versa). It is an important policy objective to keep the overall price level is stable.

Price developments

A falling prices is called deflation, a rising price level than inflation. A sharp rise in the price level is called hyperinflation, a rising price level at standstill in economic growth is called stagflation.

Relative price levels

The relative price levels are the ratio between the general level of consumer prices and general wage level.

It shows the performance of an economy, with a lower relative price levels means higher performance, as is necessary to work in this case for the same goods and services less.

In a stagflation general consumer price level is rising faster than the general wage level, thus increasing the relative price level. This shows stagflation to a loss of economic efficiency.

Expected price level

The expected price level pe, also expected price level, the price will be accepted for the following period. It is closely linked with labor market theories, in terms of wage setting, price setting and production expectations.

Expected price level and wage-setting

The expected price level belongs in the economic theory of the factors influencing the level of the nominal wage (w). The reason given is that future prices will be considered by the negotiating parties as an important factor influencing the purchasing power of future wages and thus taken into account in collective bargaining. The wage-setting function is:

Now, if workers expect an increase in prices, so you will demand a wage increase. Should employers be expected, for example, doubling their prices to be paid, then you will also be willing to double the nominal wages. In this case, the real wage (w / p ) would remain constant as change both factors in the same way. This means a positive relationship between the expected price level and nominal wage.

Into account the expected price levels in the AS- AD model

The expected price level represents an important building block in the AS- AD model

The aggregate supply

The aggregate supply represents the extent to which production changes affect the price level. The aggregate supply curve describes a mechanism through which adjust prices and wages over time, ie rise or fall.

To investigate the mode of action of pe, the wage-setting function are first (see above) assembled by the elimination of W and price-setting function to a new equation.

Pricing function:

Price-wage setting equation:

It is evident that the price level changed only when pe or u change the unemployment rate. If one replaces the unemployment rate, one obtains the following equation:

AS function:

Basically you can say that in the short run, the price level is usually equal to the price per expectation. In the medium term, however, is similar to pe to at p.

Says The AS function that p depends positively of pe and the level of production ( Y) ( under the assumption of short and medium -term constancy of the remaining variables ). So if a higher price level is expected to fit the actual to the same ratio. Is expected to increase in price level, then the wages adjust more positively to it. If a nominal wage increase to the targeted real wage to achieve, then lets the rising costs for companies. The rise in costs, the company then tilt on prices, which in turn leads to a price level increase.

At a given price expectations increased production would allow prices to rise. This illustrates the rising supply curve. If the production corresponds to their natural level of output (Y = Yn ) then corresponds to the price level of the expected price level ( in A). In conclusion it can be said that strong economic activities are causing price pressure. If Y < Yn then p < pe and the curve will shift downward. If Y > Yn then p > pe and the AS function shifts upward.

Adjustment process

The AS- AD equilibrium is dependent on pe, it determines the position of the aggregate supply curve - with an increase in the expected price levels, the AS curve shifts upwards and the other way around. A point of equilibrium, in which Y = Y n and p is PE, moves analogously.

As long as the output is above its natural level, the price level exceeds the expected. Over time, this process will, however, adjust again. Then if Y> Yn, the price expectations will rise and the people involved in the wage-setting will adjust the nominal wage correspondingly positive. Due to the increasing costs for enterprises, they will also increase their prices for their goods and services. The real money supply decreases. Now interest rates will rise and production will have to be reduced to the production quantity corresponds again to its natural level. Now Y = Yn then p = pe.

Inflation

In the context of inflation, expected inflation, and unemployment, the price-wage setting equation is used and replaced by a term. From the wage -setting formula we replace F (u, z) and assume the following relation to:

This means, for example: the reward will be the higher, the lower the unemployment rate u.

The result is the equation:

As already described, the increase in the expected price level, an increase in the actual price level, and a higher nominal wage and a, from the increased costs for businesses, resulting price increase moves to itself.

Starting from a given price level of the previous period, means the increase in the price level of the current period nevertheless an increase of the price increase from the previous period to the present - that is, a higher inflation rate.

For a given price level of the previous period, resulting a higher expected price level of the current period to a higher expected rate of price increases of the previous period to the current period - a higher expected inflation.

The fact that an increase of Pe also leads to an increase of the actual price levels may be equally applied to the inflation: an increase of the expected inflation results in an increase of the actual inflation.

Alternative approach

It is also conceivable that the expected price level pe of p, the actual price level adjusts as described in the following equation.

This would mean that the AS curve is horizontal in the short run, and not rising slightly as in the previous approach. However, this is not a substantial difference.