Amount of goods and services that can be purchased with a unit of currency
Purchasing power refers to the amount of products and services available for purchase with a certain currency unit. For example, if one spends a single unit of currency at a store to purchase products, then returns at a later date and spends a single unit of currency but is unable to purchase as many products as they had previously, the currency's purchasing power has decreased.
If one's income remains constant but prices rise, their purchasing power decreases. Inflation does not always result in decreased purchasing power, especially if income exceeds price levels. A larger real income means more purchasing power, as it corresponds to the income itself.
Traditionally, the purchasing power of money depended heavily upon the local value of gold and silver, but was also made subject to the availability and demand of certain goods on the market.[1] Most modernfiat currencies, likeUS dollars, are traded against each other for the purpose of internationaltransfer of payment for goods and services.
Scottish economistAdam Smith noted that 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 formoney or currency.
For aprice 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, whereP is the price index in that year. So, by definition, the purchasing power of a dollar decreases as the price level rises.
Adam Smith used an hour's labour as the purchasing power unit, so value would be measured in hours of labour required to produce a given quantity (or to produce some other good worth an amount sufficient to purchase the same).[2]
- ^Guy Le Strange,Purchasing Power in 1889 Compared with Same Currency in 985 CE, in: Mukaddasi,Description of Syria, Including Palestine, London 1886, p. 44.
- ^Smith, Adam (March 9, 1776).An Inquiry into the Nature and Causes of the Wealth of Nations (1st ed.). english: W. Strahan and T. Cadell, London. pp. 314, 348.
