Purchasing power
Encyclopedia
Purchasing power is the number of goods/services that can be purchased with a unit of currency
. For example, if you had taken one dollar to a store in the 1950s, you would have been able to buy a greater number of items than you would today, indicating that you would have had a greater purchasing power in the 1950s. Currency
can be either a commodity money
, like gold
or silver
, or fiat currency, or free-floating market-valued currency like US dollars. 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
.
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 it 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.
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.
The purchasing power in today's money of an amount C of money, t years into the future, can be computed with the formula for the present value
:
where in this case i is an assumed future annual inflation rate
.
Currency
In economics, currency refers to a generally accepted medium of exchange. These are usually the coins and banknotes of a particular government, which comprise the physical aspects of a nation's money supply...
. For example, if you had taken one dollar to a store in the 1950s, you would have been able to buy a greater number of items than you would today, indicating that you would have had a greater purchasing power in the 1950s. Currency
Currency
In economics, currency refers to a generally accepted medium of exchange. These are usually the coins and banknotes of a particular government, which comprise the physical aspects of a nation's money supply...
can be either a commodity money
Commodity money
Commodity money is money whose value comes from a commodity out of which it is made. It is objects that have value in themselves as well as for use as money....
, like gold
Gold
Gold is a chemical element with the symbol Au and an atomic number of 79. Gold is a dense, soft, shiny, malleable and ductile metal. Pure gold has a bright yellow color and luster traditionally considered attractive, which it maintains without oxidizing in air or water. Chemically, gold is a...
or silver
Silver
Silver is a metallic chemical element with the chemical symbol Ag and atomic number 47. A soft, white, lustrous transition metal, it has the highest electrical conductivity of any element and the highest thermal conductivity of any metal...
, or fiat currency, or free-floating market-valued currency like US dollars. As Adam Smith
Adam Smith
Adam Smith was a Scottish social philosopher and a pioneer of political economy. One of the key figures of the Scottish Enlightenment, Smith is the author of The Theory of Moral Sentiments and An Inquiry into the Nature and Causes of the Wealth of Nations...
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
Money
Money is any object or record that is generally accepted as payment for goods and services and repayment of debts in a given country or socio-economic context. The main functions of money are distinguished as: a medium of exchange; a unit of account; a store of value; and, occasionally in the past,...
or currency
Currency
In economics, currency refers to a generally accepted medium of exchange. These are usually the coins and banknotes of a particular government, which comprise the physical aspects of a nation's money supply...
.
If one's monetary income stays the same, but the price level
Price level
A price level is a hypothetical measure of overall prices for some set of goods and services, in a given region during a given interval, normalized relative to some base set...
increases, the purchasing power of that income falls. Inflation
Inflation
In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a...
does not always imply falling purchasing power of one's money income since it may rise faster than the price level. A higher real income
Real income
Real income is the income of individuals or nations after adjusting for inflation. It is calculated by subtracting inflation from the nominal income...
means a higher purchasing power since real income refers to the income adjusted for inflation.
For a price index
Price index
A price index is a normalized average of prices for a given class of goods or services in a given region, during a given interval of time...
, 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.
The purchasing power in today's money of an amount C of money, t years into the future, can be computed with the formula for the present value
Present value
Present value, also known as present discounted value, is the value on a given date of a future payment or series of future payments, discounted to reflect the time value of money and other factors such as investment risk...
:
where in this case i is an assumed future annual inflation rate
Inflation rate
In economics, the inflation rate is a measure of inflation, the rate of increase of a price index . It is the percentage rate of change in price level over time. The rate of decrease in the purchasing power of money is approximately equal.The inflation rate is used to calculate the real interest...
.
See also
- Group purchasing organizationGroup purchasing organizationIn the United States, a group purchasing organization is an entity that is created to leverage the purchasing power of a group of businesses to obtain discounts from vendors based on the collective buying power of the GPO members....
- Purchasing power parityPurchasing power parityIn economics, purchasing power parity is a condition between countries where an amount of money has the same purchasing power in different countries. The prices of the goods between the countries would only reflect the exchange rates...
- Consumer Price IndexConsumer price indexA consumer price index measures changes in the price level of consumer goods and services purchased by households. The CPI, in the United States is defined by the Bureau of Labor Statistics as "a measure of the average change over time in the prices paid by urban consumers for a market basket of...
- Fair tradeFair tradeFair trade is an organized social movement and market-based approach that aims to help producers in developing countries make better trading conditions and promote sustainability. The movement advocates the payment of a higher price to producers as well as higher social and environmental standards...
- Free tradeFree tradeUnder a free trade policy, prices emerge from supply and demand, and are the sole determinant of resource allocation. 'Free' trade differs from other forms of trade policy where the allocation of goods and services among trading countries are determined by price strategies that may differ from...
- Group buy
- Collective buying powerCollective buying powerCollective buying power is when a group of consumers come together and use the old rule of thumb, there's power in numbers, to leverage the group size in exchange for discounts.- In the marketplace :...
- Constant Purchasing Power AccountingConstant Purchasing Power AccountingConstant-purchasing-power accounting is:a consistent method of indexing accounts by means of a general index which reflects changes in the purchasing power of money. It therefore attempts to deal with the inflation problem in the sense in which this is popularly understood, as a decline in the...
- Oil burdenOil burdenOil burden is the volume of petroleum consumed multiplied by the average price and divided by nominal gross domestic product.This gives the proportion of the world economy devoted to buying oil. It is a concept developed by Veronique Riches-Flores of Société Générale. It is also referred to as...
- InflationInflationIn economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a...
- Sustainability
- Carrying capacityCarrying capacityThe carrying capacity of a biological species in an environment is the maximum population size of the species that the environment can sustain indefinitely, given the food, habitat, water and other necessities available in the environment...
- Consumption (economics)Consumption (economics)Consumption is a common concept in economics, and gives rise to derived concepts such as consumer debt. Generally, consumption is defined in part by comparison to production. But the precise definition can vary because different schools of economists define production quite differently...
- ConsumerismConsumerismConsumerism is a social and economic order that is based on the systematic creation and fostering of a desire to purchase goods and services in ever greater amounts. The term is often associated with criticisms of consumption starting with Thorstein Veblen...
External links
- MeasuringWorth.com has a http://www.measuringworth.com/calculators.index.php with different measures for bringing values in UK Pounds from 1264 to the present and in US Dollars from 1774 up to any year until the present. The Measures of Worth page discusses which would be the most appropriate for different things.
- Purchasing Power Calculator by Fiona Maclachlan, The Wolfram Demonstrations Project.