Reviewed by Aug 27, 2020| Updated on
What is Purchasing Power?
Purchasing power is a currency's value expressed in terms of the number of goods or services that can be bought by one unit of capital. Purchasing power is significant; while everything else is equal, inflation reduces the number of goods or services you might purchase.
In financial terms, purchasing power is the dollar amount of credit available to an investor to purchase new securities in the brokerage account against the current marginal securities.
Understanding Purchasing Power
Inflation lowers the value of the purchasing power of a currency, having the effect of a price rise. In the traditional economic sense, you would compare the price of a good or service against a price index, such as the Consumer Price Index (CPI) to measure the purchasing power.
Purchasing power affects every sector of the economy, from consumers who buy commodities to investors and stock prices to economic prosperity in a region.
When the purchasing power of currency declines due to excessive inflation, serious negative economic consequences occur, including increasing costs of goods and services leading to high living costs, as well as high-interest rates, impacting the global market, and ultimately declining credit ratings.
More About Purchasing Power
Purchasing price parity (PPP) is one concept relevant to purchasing power. PPP is an economic theory that calculates the amount that must be applied to the price of an item, given the exchange rates of two countries so that the ratio matches the purchasing power of each currency.
PPP is used to compare income levels of countries with other related economic data relating to the cost of living, or potential inflation and deflation rates.
Gain/Loss in Purchasing Power
Gain/loss in purchasing power is an increase or decrease in how much consumers with a given amount of money can purchase. As prices rise, customers lose buying power and recover buying power as prices fall.
Causes of loss of purchasing power include government regulations, inflation, and manmade and natural disasters. Deflation and technological innovation are the reasons for the increase in purchasing power.