Price level and inflation are two different measurements of how the economy is doing. Inflation is the rate at which the general prices for goods and services rise, while the price level is the average price of a basket of goods and services over time.
How does Inflation affect Price Level?
Inflation entails increasing the prices of goods or services in a particular economy. This means that the main objective of inflation is an increase in prices. When an economy’s price level rises, the average price of goods and services also increases. The average price might remain constant, but eventually, they will adjust to the inflation prices and increase as well [Source]. Inflation tends to cause a rise in the price level.
How is Inflation different from the Price Level?
According to Wikipedia, inflation is a “general increase in the price of goods and services in an economy” [Source]. During inflation, the general price level tends to increase, affecting the buying power of the local currency and customers. Currency units will buy fewer goods and services, raising a red flag as people will likely experience intense poverty. On the other hand, price level refers to a “hypothetical measure of overall prices for some set of goods and services, in an economy or monetary union during a given interval, normalized relative to some base set” [Source]. The general price level is measured using a daily price level which denotes an average price on a larger scale. The price level is the “buying power of money or inflation” [Source], and by establishing this price level, economists will be interested in revealing “how much people can buy with the same dollar of currency.” Also, the price level is the “accumulative prices of goods and services, and it is affected by the rate of inflation” [Source].
So, a clear distinction between inflation and price level is that inflation is a price increase, and price level is the pricing measurement of goods and services at a particular moment.
How to Calculate the Inflation Rate
The inflation rate is the “rate at which inflation increases over a specific period. This rate reflects the relationship between currency value and the cost of goods and services” [Source]. It is calculated using this formula: Inflation Rate = ((B-A)/A) x 100, in which A is the starting cost and B is the ending cost.
So, to calculate the inflation rate, subtract A from B, divide the result by A, and convert the result into a percentage by multiplying it by 100. The final result becomes the rate of inflation.
What is the Price Level in Economics?
In economics, the price level is the “average price for all goods and services presently sold in the marketplace” [Source].
Causes of Inflation
Inflation is caused by various factors, depending on the state of the given economy. Inflation can be caused by a rise in the cost of production, and firms or producers might feel the need to increase their prices. Also, it can be triggered by an increase in customer or consumer demand, and service providers exploit this gap to get more profits from their customers. Price gouging is another common cause of inflation, mainly unleashed by service providers and companies to maximize profits. Sabotage of the economy can result in inflation, especially if done by a powerful economic player or foreign influence. In governance, inflation may result from poor or wrong economic policies or the over-dominance nature of monopolies that overuse local resources.
Lack of viable competition in an industry empowers economic players to play around with the currency and end up hiking prices to abnormal levels. Governments are also blamed for causing inflation through printing and giving away more money to citizens until the streets are flooded with money. Other administrations tend to devalue legal tender and make it almost obsolete on the global market. An increase in public spending is another common cause of inflation witnessed in our modern world, where people are chasing after a luxurious life. Other factors are population growth, hoarding, exports, increase in public spending, and deficit financing of government spending also contributed to inflation.
An example of inflation can be seen in the case of Zimbabwe, which experienced hyperinflation in the 2000s. It was bad to the extent of printing trillion and quad-trillion dollar notes [Source].
Is General Price Level Micro or Macro
The General Price level is macro [Source].
General Price Level in Macroeconomics
The General Price level in macroeconomics states that “when the general price level rises, the value of money (or the purchasing power of money) falls.”
Inflation Rate Formula with the Price Level
The inflation rate formula with price level is calculated by dividing the cost of the market basket in a particular year by the cost of the same market basket in the base year.