Price Level - Theoretical Foundation

Theoretical Foundation

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 of goods and services, the total value of transactions in at time is

where

represents the quantity of at time
represents the prevailing price of at time
represents the “real” price of at time
is the price level at time

A 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.

Read more about this topic:  Price Level

Famous quotes containing the words theoretical and/or foundation:

    There are theoretical reformers at all times, and all the world over, living on anticipation.
    Henry David Thoreau (1817–1862)

    If all political power be derived only from Adam, and be to descend only to his successive heirs, by the ordinance of God and divine institution, this is a right antecedent and paramount to all government; and therefore the positive laws of men cannot determine that, which is itself the foundation of all law and government, and is to receive its rule only from the law of God and nature.
    John Locke (1632–1704)