Discover the True Meaning of Purchasing Power

Explore the concept of purchasing power and how it impacts your daily life, investments, and broader economic scenarios.

Purchasing power is the value of a currency explained by the amount of goods or services one unit of money can buy. Over time, purchasing power can diminish due to inflation, as rising prices reduce the quantity of goods or services that can be bought. This concept is often referred to as a currency’s buying power.

In investment contexts, purchasing power—or buying power—refers to the credit amount available to a customer, based on the marginable securities in their brokerage account.

Key Takeaways

  • Purchasing power measures the quantity of goods or services one unit of currency can buy at a specific time.
  • Inflation erodes a currency’s purchasing power over time.
  • Central banks manipulate interest rates to stabilize prices and maintain purchasing power.
  • One metric for purchasing power in the U.S. is the Consumer Price Index (CPI).
  • Globalization has interconnected currencies, making responsible management of purchasing power globally imperative.

Understanding Purchasing Power

Purchasing power affects various economic activities, from consumer purchases to investments and overall economic health.

Inflation reduces purchasing power by decreasing the value of money. In economic terms, this is equivalent to an increase in the price of goods or services. To measure purchasing power traditionally, compare the price of goods or services against a price index, such as the Consumer Price Index (CPI).

Imagine working the same job your grandfather did 40 years ago. Today, you would need a much higher salary to maintain the same quality of life. Similarly, a homebuyer with a $300,000 to $350,000 budget 10 years ago had more and better options than someone today in the same price range.

A severe decline in purchasing power caused by excessive inflation can have dangerous economic impacts, such as increased cost of living, higher interest rates, and falling credit ratings, potentially leading to an economic crisis.

Purchasing Power and CPI

Governments institute policies and regulations to protect currency purchasing power and keep the economy stable. They also monitor economic data to gauge changes. For example, the U.S. Bureau of Labor Statistics (BLS) calculates price changes through the Consumer Price Index (CPI).

CPI, a measure of inflation and purchasing power, calculates price changes in consumer goods and services, particularly transportation, food, and medical care. Changes measured by CPI can signal shifts in the cost of living and potential deflation.

Purchasing Price Parity

Purchasing Price Parity (PPP) is an economic theory that estimates the amount an item should be adjusted for parity between two countries’ exchange rates. PPP helps compare economic activity, income levels, cost of living, and inflation rates between countries.

The World Bank’s International Comparison Program provides data on purchasing power parities between various countries.

Purchasing Power Loss or Gain

Purchasing power loss or gain measures how much consumers can buy with a given amount of money. Purchasing power decreases when prices increase and increases when prices decrease.

Example: Laptops that cost $1,000 two years ago but cost $500 today represent a purchasing power gain, allowing you to buy a laptop and additional goods valuing $500 with the original $1,000.

Examples of Purchasing Power Loss

Germany After WWI

Germany experienced drastic hyperinflation in the 1920s post-WWI due to hefty reparations payments, leading to an economic collapse and rendering the German mark nearly worthless.

The 2008 Financial Crisis

During the 2008 financial crisis, there was a significant drop in purchasing power. Governments globally initiated policies like the Federal Reserve’s quantitative easing to stabilize economies and protect purchasing power.

Investment Strategies Against Purchasing Power Risk

Retirees and those on fixed incomes are particularly wary of purchasing power loss. They should ensure their investments provide returns equal to or greater than the inflation rate.

Investments like Treasury inflation-protected securities (TIPS) and commodities like oil can help mitigate purchasing power risks. Fixed-rate investments such as bonds are more vulnerable to purchasing power risk.

The Bottom Line

Long-term investors understand that purchasing power loss significantly impacts their investments. Elevating inflation rates mean that goods and services become pricier, decreasing purchasing power.

It is crucial to seek investment returns that exceed the inflation rate and remain aware of international economic trends affecting long-term investments.

Related Terms: inflation, deflation, consumer price index, purchasing power parity, hyperinflation, quantitative easing.


  1. The World Bank. “International Comparison Program (ICP)”.

Get ready to put your knowledge to the test with this intriguing quiz!

--- primaryColor: 'rgb(121, 82, 179)' secondaryColor: '#DDDDDD' textColor: black shuffle_questions: true --- ## What does "purchasing power" refer to in economics? - [ ] The ability to borrow money from banks - [x] The value of money, measured by the quantity and quality of products and services it can buy - [ ] The interest rate applied to savings - [ ] The strength of a country’s currency compared to other currencies ## Which factor directly affects purchasing power? - [x] Inflation - [ ] Exchange rates - [ ] Loan interest rates - [ ] Stock market performance ## When inflation rises, what generally happens to purchasing power? - [ ] It remains the same - [ ] It increases - [x] It decreases - [ ] It fluctuates unpredictably ## How can purchasing power parity (PPP) be used? - [ ] To measure corporate profits - [x] To compare the cost of living between countries - [ ] To calculate domestic inflation rates - [ ] To predict stock market performance ## What is one method to preserve purchasing power over time? - [ ] Avoiding investments altogether - [ ] Spending money quickly - [x] Investing in assets that historically outpace inflation - [ ] Keeping all money in a savings account ## Which scenario below best illustrates a decrease in purchasing power? - [ ] Mark's salary increases, and he buys more goods than before - [ ] Jane uses her same salary to purchase the same number of goods year after year - [x] Clara finds that the same amount of money buys fewer groceries over time - [ ] Robert receives a bonus and pays off his loans ## What effect can deflation have on purchasing power? - [ ] Decrease purchasing power - [x] Increase purchasing power - [ ] Eliminate purchasing power - [ ] Make no change to purchasing power ## How do wages relate to purchasing power during a period of inflation if they don't increase? - [ ] Wages have no relation to purchasing power - [ ] Wages will still increase purchasing power - [ ] Purchasing power will remain unaffected - [x] Real purchasing power will decrease ## What might retirees be most concerned about regarding purchasing power? - [x] That fixed incomes do not keep up with inflation - [ ] That their investments earn too much - [ ] That bank interest rates are too high - [ ] That exchange rates fluctuate too frequently ## Which financial product is designed to help preserve purchasing power? - [ ] Fixed-rate mortgage - [ ] Bond with a low yield - [x] Treasury Inflation-Protected Security (TIPS) - [ ] Regular savings account