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The value of a currency regarding the quantities of services and goods that one unit of money can buy is called purchasing power (Fisher, 2006). This idea is essential because, given that everything is constant, inflation reduces the number of goods and services an individual can buy. When it comes to the investment sector, purchasing power is understood as the dollar amount of credit that is available in the market to acquire extra protection against the contemporary marginal securities of the brokerage account. Therefore, we can argue that purchasing power is rooted in the law of one price. This law declares that alike products ought to have an identical price in various or changing markets. For example, products that are easily traded such as iron and steel, prices should be identical or within the same range.
A breakdown of the purchasing power
In measuring purchasing power in the economics point of view, a comparison is made against the price index such as the consumer price index (CPI). For example, in a work environment if a person made the same salary equivalent to a person paid a similar amount for the same position 50 years ago more income will be required to maintain the similar quality of living. Similarly, a homebuyer looking to purchase a house in the range of $ 450,000 to $ 500,000 will have more options if a similar amount was present 10 to 20 years ago (Yazgan, 2003). Adhering to this concept, it can be argued that purchasing power is closely related to time value of money a concept explained through inflation.
The Purchasing power context
Purchasing power impacts every aspect of business and economics, from consumers purchasing products, investors, and stock prices, to a nation’s economic prosperity. In the instance where a currency’s purchasing power declines because of excess inflation, adverse negative repercussions are felt such as increasing cost of living targeting the prices of services and commodities coupled with high-interest rates. Thus, it can be argued that to purchasing power in times of recession contribute to the economic crisis.
Thus, it is worth mentioning that a nation’s government must institute policies and regulations to protect its currency’s purchasing power to keep the economy in a healthy condition. In monitoring the purchasing power, the consumer price index is used (CPI). Under this case, CPI is used to examine the weighted average of prices of a basket of consumer services and products such as transport, food, and medical care. The monitoring of purchasing power is executed through recording price changes of commodities and services that are associated with the cost of living. Importantly, the CPI is also used in identifying a period of inflation and deflation.
Purchasing Price Parity (PPP) is yet another concept that is related to purchasing power. Under this case, the purchasing price parity is an economic theory that aids in the estimation of the amount needed to adjust the price of an item where two countries exchange rates match concerning currency’s purchasing power. Therefore, for the exchange to match regarding currency’s purchasing power, PPP is utilized to compare nation’s income levels and other relevant economic data regarding the cost of living or estimated rates of inflation and deflation.
Purchasing Power History
In the economy of different nations, there are historical examples of adverse inflation and hyperinflation of a currency’s purchasing power. Under this case, there are several causes behind this phenomenon. For instance, a devastating conflict will tend to give rise to economy collapsing. An example is during the World War I, where the aftermath led to Germany experiencing extreme economic repercussions and unprecedented hyperinflation because of some reparations Germany had to pay. During this period, Germany was unable to pay the reparations and in an attempt to deal with the economic consequence Germany printed paper notes to buy foreign currencies. As a result, there was a high inflation an aspect that rendered the German currency valueless with nonexistent purchasing power.
In today’s time, the impacts of the loss of purchasing power are also felt in the aftermath of the 2008 global economic crisis and during the times of European sovereign debt crisis. The increased rate of globalization and the implementation of the euro currencies can inextricably be linked with the purchasing power crisis. In such cases, the government is compelled to institute regulations and policies o control inflation rate with the aim of protecting purchasing power and trying to avert period of recessions. For example during the 2008 recession crisis, the U.S. Federal Reserve in protecting the purchasing power kept very low-interest rates (Taylor & Taylor, 2004). Additionally, the Federal Reserve implemented quantitative easing where interest rates were lowered, and supply of money was increased. The aim was to increase capital a concept that triggers increased lending and liquidity. The quantitative easing was halted when the economy began to stabilize, and the concept has since been borrowed by European Central Bank in attempts to protect the purchasing power.
Nature of purchasing power
In a normal economy, there is purchasing power loss or gain. A gain or loss in purchasing power is determined by how much consumers can buy with a specific amount of money. Consumers are said to lose purchasing power when prices increase. Therefore, during the period of inflation prices of commodities and services tends to rise. As a result, consumers are compelled to spend more than anticipated and are thereby said to experience purchasing power (Pedroni, 2001). In the case of purchasing power gain, supply is more than demand and prices of commodities and services decrease. As a result, the consumers spend less and thereby argued to have gained purchasing power. The loss or gain of purchasing power is triggered by government regulations, inflation, deflation, technological innovation, natural, and manmade disasters.
Summarily, purchasing power is also used in measuring the performance of businesses and companies. For instance, most corporations around the globe such as Walmart always strive towards achieving a gain in purchasing power. A company is argued to have high purchasing power when the cost and expenses are within the estimated range. For example, in Walmart stores, the corporation aims at purchasing products for sale to customers without stretching its budget. In the instance where a company purchases materials for operations at low cost than anticipated, it is argued that the company has a high purchasing power. Consequently, in the instance where a corporation spends more than anticipated the company is argued to have low purchasing power. Thus, purchasing power is used to measure the performance of a corporation. In conclusion, purchasing power is a probable measure of economic performance of a nation as well as a company.
Fisher, I. (2006). The Purchasing Power of Money: Its' Determination And Relation to Credit Interest And Crises. Cosimo, Inc..
Pedroni, P. (2001). Purchasing power parity tests in cointegrated panels. Review of Economics and Statistics, 83(4), 727-731.
Taylor, A. M., & Taylor, M. P. (2004). The purchasing power parity debate. The Journal of Economic Perspectives, 18(4), 135-158.
Yazgan, M. E. (2003). The purchasing power parity hypothesis for a high inflation country: a re-examination of the case of Turkey. Applied Economics Letters, 10(3), 143-147.
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