Purchase power is a measure of what your money can buy — here’s how it can impact your finances
- Purchasing power refers to how much you can buy with a unit of currency, such as a dollar.
- If your purchasing power drops, your money may become less valuable or useful over time.
- Inflation impacts purchasing power, but changing wages can also impact your finances.
If you find a $100 bill that was printed 20 years ago, it will still be worth $100 dollars. But you can probably buy a lot less with it today than you could have when it first came off the printing press.
Inflation measures how prices for goods and services increase over time. But purchasing power looks at the flip side — how much can a single unit of currency buy?
Purchase power and inflation
Economists can track changes in purchasing power to better understand the impact of inflation on consumers’ buying power. In a sense, purchasing power and inflation are two sides of the same coin. Purchasing power measures what a unit of currency can buy, while inflation measures rising prices.
What is inflation?
Inflation is the increase in the prices of goods and services over time. The Consumer Price Index (CPI) is a commonly used tracker of inflation. It uses quarterly survey data to gather the average prices for a market basket of consumer goods and services in urban areas. The basket includes common household purchases, such as cereal, milk, coffee, clothing, and medical care.
The CPI surveys even account for “shrinkflation” (e.g., when a cereal box costs the same, but there’s less cereal inside) by comparing prices per unit. For example, you can look up the price of sliced bacon per pound and see how it’s changed since 1980.
Purchase power loss and gain
Purchasing power losses and gains reflect changing prices of goods. For instance, “as inflation rises, purchasing power falls because one needs more units of currency to acquire the same basket of goods,” says Johnson.
Inflation and deflation can directly impact purchasing power, but they might not be the only factors. For example, a new government regulation could impact an entire industry and lead to changing prices for goods and services in that sector. Or a new technology could increase manufacturing efficiency, decreasing the cost of certain products.
Purchasing power in the real world
While purchasing power looks at what a unit of currency can buy, it doesn’t account for changing wages. “Real wage” changes are a measure of changing wages minus inflation. In effect, it’s a measure of a household’s purchasing power over time.
There are also other factors you may want to consider when trying to determine your future buying power and budget.
For example, cell phones may be a large expense for households today — but they’re a relatively new invention that couldn’t have been included in previous “baskets of goods.” Who knows what goods or services will be invented and added to the “basket” later.
“Also, purchasing power doesn’t take into account improvement in many goods that may be in a basket,” says Johnson. “The price of televisions have dropped over time, [but] the quality of those goods has increased over time.” Johnson points to medical care as another example. While medical care costs might have increased over time, the advances and quality of care may have also increased.
Your individual buying power can also be influenced by other factors, including government and manufacturers’ policies. For instance, a bottle of Coca-Cola cost five cents for over 70 years, in part because the vending machines were designed to only accept nickels. Or, you might pay a lot more (or less) for a gallon of gas or pack of cigarettes than someone else depending on the local tax rates.
The financial takeaway
Purchasing power measures how much a unit of currency can buy. It’s often impacted by inflation and deflation — the changing cost of goods and services. But policy changes and major events or industry changes can also influence purchasing power.
Changes in purchasing power can play an important role in national and local policymaking. And you may want to consider your future purchasing power as you design or update your investment strategy. But also beware of and account for its shortcomings when trying to forecast your future expenses.
Money and Purchasing Power
How to increase your purchasing power?
Purchasing Power – Real Economy: Crash Course
Purchasing power is the amount of goods and services that can be purchased with a unit of currency. For example, if one had taken one unit of currency to a store in the 1950s, it would have been possible to buy a greater number of items than would be the case today, indicating that the currency had a greater purchasing power in the 1950s.
If one’s monetary income stays the same, but the price level increases, the purchasing power of that income falls. Inflation does not always imply falling purchasing power of one’s money income since the latter may rise faster than the price level. A higher real income means a higher purchasing power since real income refers to the income adjusted for inflation.
Traditionally, the purchasing power of money depended heavily upon the local value of gold and silver, but was also made subject to the availability and demand of certain goods on the market. Most modern fiat currencies, like US dollars, are traded against each other and commodity money in the secondary market for the purpose of international transfer of payment for goods and services.
As Adam Smith noted, having money gives one the ability to “command” others’ labor, so purchasing power to some extent is power over other people, to the extent that they are willing to trade their labor or goods for money or currency.
For a price index, its value in the base year is usually normalized to a value of 100. The purchasing power of a unit of currency, say a dollar, in a given year, expressed in dollars of the base year, is 100/P, where P is the price index in that year. So, by definition, the purchasing power of a dollar decreases as the price level rises.
Adam Smith used an hour’s labour as the purchasing power unit, so value would be measured in hours of labour required to produce a given quantity (or to produce some other good worth an amount sufficient to purchase the same).
EUROSTAT defines purchasing power standard (PPS) as an artificial currency unit.
Fisher, Irving (1867–1947)
W.J. Barber, in International Encyclopedia of the Social & Behavioral Sciences, 2001
3 Early Work in Monetary Theory
The Purchasing Power of Money (1911) was conceived as an exercise in establishing the validity and usefulness of the quantity theory of money, a doctrine that had been politically contaminated in the polemics over ‘free silver’ in the 1890s. In Fisher’s formulation, ‘the equation of exchange’ was written as MV+M′ V′=PT.
(In this expression, M represented the quantity of cash and V the velocity of its circulation; M′ stood for total deposits subject to check and V′ for the average velocity of their circulation; P was defined as an average price and T as the volume of trade.)
This book was a vigorously monetarist document in which Fisher maintained that changes in the general price level were linked to proportionate changes in the money supply. This was true in the ‘normal period,’ defined as a state of equilibrium in which the values of T and the V‘s were constant. His choice of terminology on this point bred misunderstandings: he recognized readily that economic reality was typified by ‘transition periods’—when adjustments to disturbances were being worked out—in which the constancies did not hold.
Fisher was not content to offer solely an analytic explanation for variations in the purchasing power of money. Convinced as he was that monetary instability produced distributive injustices by distorting the relative positions of creditors and debtors, he felt obliged to suggest a corrective.
His proposed remedy prescribed that changes in the general price level should be offset by variations in the gold content of the dollar (i.e., the ‘compensated dollar’ plan). But this policy recommendation did not mesh with the analysis presented in The Purchasing Power of Money.
The ‘compensated dollar’ scheme rested essentially on a ‘commodity theory of money’ in which the real value of money was determined by the value of its gold equivalent. This conclusion did not follow from the ‘equation of exchange’ that Fisher had set out as the basis for his ‘quantity theory of money.’ Schumpeter (1948) and Patinkin (1993) have suggested that this oddity can be explained because Fisher, the reformer, got the better of Fisher, the scholar.
Opportunities to multiply purchasing power affords libraries a great opportunity to level the playing field and, in many instances, shift the negotiation in their favor. Vendors are in business to make money. Providing an opportunity for them to increase overall sales is a great way to reduce the cost for individual libraries.
A library that belongs to a consortium or some other group can use this as way to gain concessions in exchange for advocating for a joint purchase. This can be especially effective if the library is well regarded in the consortium or is the flagship campus of a university system.
Vendors will also use the purchasing power of libraries to their advantage by offering exclusive deals to such groups. The hope here is that libraries will be more motivated to purchase something due to a couple of reasons.
First, the deal is “too good to pass up” and the libraries do not want to miss the opportunity to add something to their collection at a discounted price. Second, there is pressure as other libraries will be unable to take advantage of the offer if there is not a minimum number of libraries participating.