Definition: Purchasing power is =the financial ability of an individual, or entity to purchase/buy any products or services. The purchasing power of the associated people plays a crucial role in strengthening the economy.
Talking about this, Robert Bernard Reich, an American liberal economist, professor, author, and political commentator says-
“No economy can continue to function when the vast middle class and everybody else doesn’t have enough purchasing power to buy what the economy is capable of producing without going deeper and deeper into debt.”
So, the purchasing power of the consumers, buyers or citizens is essential for the inclusive and sustainable growth of any economy.
In this post, we will be covering different aspects of purchasing power to understand its significance in business management. So, without any further delay, let us get started right away-
What is Purchasing Power?
Millions of goods and products are manufactured daily. All of them are brought in the market for the customers to buy. In the old days, there used to be different forms of trade. People used to exchange goods according to their needs. This method was termed as the ‘barter system’.
After the emergence of currencies, money came into play. Nowadays, customers exchange money in the form of currencies for the goods they wish to buy. This act is called a purchase.
The purchasing power, also called the buying power, refers to the capacity of a customer to purchase goods or services in one unit of money. It can also be called the value of money.
Significance of Purchasing Power
Purchasing power is highly significant in the economics of a nation to determine the financial condition of the citizens.
In investment terms, the purchasing power is measured with keeping a dollar in reference.
The dollar amount of credit available to a customer to buy additional securities against the existing marginal securities in the brokerage account is called purchasing power.
Purchasing Power and Inflation
A general rise in the prices of goods and services is called inflation.
Inflations have various reasons. There can be general inflation caused by the changes in the goods supply, changes in the supply of the currency by the government.
Also, inflation is sometimes caused due to extreme political and economic conditions as well.
Situations like World Wars, sudden recession, and a financial upheaval also stand as causes for inflation. In inflation, there is a decrease in the value of money.
That leads to a reduction in the purchasing power of the consumers.
Purchasing power is one of the parameters considered while determining the rate and impact of inflation. The fall in purchasing power is not a desirable condition for anyone.
The effects of a decrease in purchasing power can be seen in society, on the businesses and the nation’s economic conditions. It leads to serious financial issues like poverty and societal disparity.
It affects investment plans and government regulations.
Purchasing power affects the stock prices and the stock market conditions at large.
The purchasing power also determines the value of the currency in international trade.
Theories about Purchasing Power and its role in Socioeconomics
There have been several thesis and theories written about the purchasing power and its effects and impacts.
It needs to be monitored and kept track of now and then by the leading economists and the economic policy-makers of the nation. There are various indexes devised in economics to understand and grade the purchasing power.
One of them is the CPI (Consumer Price Index).
This index is used to compare the prices of goods and services. It is also called as the cost of living.
A famous example of changes in the purchasing power is that of the salaries in different periods.
A salary of $1000 was enough around five years ago to buy the goods necessary for a good living. But, today, to obtain the same quantity and quality of products, one needs more money.
This indicates a decrease in the purchasing power of the money at a definite time.
These days, the Purchasing Price Parity (PPP) is a theory used to compare the country’s income and its other economic factors to balance the cost of living and the rates of inflation and deflation.
It also estimates the adjustments to be done to maintain an excellent and affordable living in the country.
The incidents of hyperinflation and its effects on purchasing power can be traced back to centuries ago.
Hyperinflation is the most severe case of inflation; wherein there is an unreasonable and breathtaking increase in prices. This has severe effects on the purchasing power and the quality of living of the citizens.
One of the oldest examples is that of the aftermath of World War I. Wars always cost a lot- a lot of lives, a lot of humanity, a lot of destruction and a lot of monetary funds.
Germany faced hyperinflation due to the reparations and substantial economic loss.
That rendered the citizens powerless concerning their purchasing capacities.
The 2008 financial crisis and the European sovereign debt crisis also had aftermath in the form of inflation and a decrease in the purchasing power. The increased globalization and the emergence of newer currencies in the market made the financial conditions more vulnerable.
In the same year, 2008, the US also faced such a situation. To ease this out, the US Federal Reserve came up with a policy called ‘quantitative easing’.
Through this, it bought the government and other market securities at a much lower interest rate which was near to zero to decrease inflation and increase the money supply and purchasing power. Once the situation eased out, these regulations were terminated.
The European Central Bank (ECB) also pursued this ‘quantitative easing’ and the European Economic, and Monetary Union has applied strict rules on financial policies.
Now, all the countries aim to keep the rate of inflation only at 2% not to cause any undesirable and radical changes in the purchasing power of the citizens.
Effects of Increase and Decrease in Purchasing Power
Purchasing power, as mentioned above, is the power to buy goods and services in one unit of money.
It is a regular pattern that the customers lose purchasing power when the prices increase, and they gain it back when the costs decrease.
Whenever there is an unfavorable change in the purchasing power that does no good for the national economy, the government comes up with rules and regulations which curb this economic imbalance and remove financial disparity.
Purchasing power is an indicator of the present-day economic and market conditions.
While addressing the importance of purchasing power, Bernard Mannes Baruch, an American financier, stock investor, philanthropist, statesman, and political consultant says-
“Increased wages, higher pensions, and more unemployment insurance, all are of no avail if the purchasing power of money falls faster.”
Purchasing Power Wrap Up!
The purchasing power is an essential and straightforward method to discern the value of money and set economic policies like budgets.
A great economist Adam Smith once quoted that having money gives one the ability to command others’ labour.
Hence, the purchasing power, to some extent, can be defined as the power over other people, to the extent that they are willing to trade their labor or goods for money or currency.
So, what are your thoughts about the importance of purchasing power?
What are your takes about the purchasing power of the general public in your country? Update us in the comments below.