Purchasing Power

Beginner

Purchasing power is the amount of goods and services that a sum of money can buy. When prices rise, the same amount of money buys less, so its purchasing power falls.

The number on a banknote does not change, but what it can buy does. Purchasing power describes that real buying ability.

Suppose a basket of groceries costs 50 this year. If you have 500, you can buy 10 baskets. If prices rise by 10% and the basket now costs 55, your 500 buys only about 9 baskets. Your money is the same, but its purchasing power has fallen by about 9%.

The main force that reduces purchasing power is inflation, the general rise in prices over time. Even low inflation adds up: at 3% a year, prices roughly double in about 23 years, so money kept in cash for that long would buy only about half as much.

This is why savers look for returns that at least match inflation. If your savings earn 2% a year while prices rise by 3%, your balance grows, but your purchasing power shrinks. Wages work the same way: a pay rise smaller than inflation is, in real terms, a pay cut.

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