What are “real” prices?

by Neil Faulkner on 19 August 2011  |  1 comment
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When someone at lovemoney.com writes about the “real” price of food, electricity, property, or other things, it's not because we're concerned about all those “fake” prices out there.

If a piece of pie at the pie shop costs £1 on Monday but £2 on Wednesday, it has doubled in price. If nothing else happens, the “real” price is now twice as high.

However, if on Tuesday the printing presses get rolling at full speed, doubling the amount of pounds in the country, this new money will spread throughout the economy to us consumers – as new money always does.

So now, when we get to Wednesday, the cost of pie may have doubled to £2 but, since consumers have twice as much money, the pie is equally affordable on the Wednesday as it was on Monday. Consumers find it neither easier nor harder to buy a piece of pie, which means the “real” price of the pie is unchanged.

But if on the Wednesday morning a new pie shop opens, introducing more pies and more competition, the price might not rise so much. Maybe the cost of a piece of pie just goes up to £1.50. The price has gone up 50p but, since we've got twice as much money, we can now afford a piece of pie more easily: the “real” price of the pie has got lower, because with our extra money we can pay £1.50 on Wednesday more easily than we could pay £1 on Monday.