Price level consequences

Price level has various consequences, positive and negative. A comparison of the price level is made a) in the same country between different time periods which are usually years or b) between countries during the same time period which is usually a year. An increase in the price level is called inflation. With inflation, some groups are disadvantaged as not all prices rise equally.

Pensioners and depositors usually suffer because pension and interest rate increases are slower than general price increases. Wages may also not follow the increase in the prices of products and services. Then we have a reduction in purchasing power for pensioners, depositors and wage earners due to inflation.
Consider the consequences of the price difference between countries.

Let's take two countries that have almost the same real per capita income but in one the price level is twice as high. One such case is Greece and Turkey. We said that the average Greek and the average Turk have the same economic level as long as they are within their countries. In fact, it is slightly higher in Turkey. But when they go outside their countries, the average Greek has twice as much.

Something similar happens for a foreign worker working in one of the two countries. Suppose there are two foreign workers from Pakistan, one in Greece and the other in Turkey. The one in Greece gets 800 euros a month while the one in Turkey makes 400 euros a month. They spend 3/4 of their salary for living expenses. That is, the one in Greece spends 600 euros and the other in Turkey 300 euros.

These ensure them the same standard of living because prices in Greece are double. Since they spent 3/4 of their income, the foreign worker in Greece has 200 euros left each month and the one who lives in Turkey 100 euros left. In one year, the amount would be 2400 euros for the foreign worker in Greece and 1200 euros for the one in Turkey

What the foreign worker buys in Greece with 2400 euros, the other buys in Turkey with 1200 since prices in Greece are double. Let's say that what they have left, they send once a year to their country, Pakistan. The one in Greece sends 2400 euros to Pakistan, while the one in Turkey sends half that amount 1200 euros. While 2400 euros in Greece have the same purchasing power like 1200 in Turkey, in Pakistan they have double purchasing power, for whatever price level is there.

On the other hand, it is most likely cheaper for foreign tourists to go on vacation in Turkey. We did not say certainly because the index is the average from all goods and services. We would have to examine specifically the prices for goods and services tourists buy. Foreign tourism is like exports even though it is produced within the country. The cheapest tourist destinations are those that have a lower price level.

If you want cheap holidays abroad, you should be looking for countries with low price level. Conversely, if you don't want to pay a lot on a holiday abroad, you should avoid countries with a high price level because they are more expensive. Similarly, products from countries with a low price level are cheaper while products from countries with a high price level are more expensive.

If a product or service has a lower price, it does not mean that it has inferior quality. It may come from a country with a lower price level. As consumers it is in our interest to import from countries with a low price level. As producers it is in our interest to import raw materials and energy resources from countries with a low price level and export to countries with a high price level.

A higher price level generally hurts the domestic economy. It makes imports cheaper and exports more expensive. Thus domestic products become less competitive both inside the country and abroad. This in the long run has a negative effect on real GDP growth. Per capita income is GDP divided by total population and shows how rich a country is.

Domestic products and services are part of the country's GDP while imported goods are part of the GDP in foreign countries. When GDP growth declines, the country suffers. Reduced growth can be positive or negative. We will deal with growth rates later. The real economic level measured by per capita income at purchasing power parity is negatively affected.

Adopting euro raised the price level in Eastern European countries and made products and services less competitive. This is not the case in all countries. In other Western European countries, the euro lowered the price level. Of course, the price level is not the only factor that affects the competitiveness of products and services. Another important factor is productivity which we will look at later.

In conclusion, price level has positive and negative consequences. These are not the same for everyone. A foreign worker sending money to his/her home country would prefer high price level. A foreign tourist should prefer low price level while a domestic tourist traveling abroad the opposite for his/her home country. Consumers should prefer high price levels. Producers would prefer low price levels. Generally high price levels are bad for the economy but they are not the only factor.