Purchasing Power

Definition

Purchasing power refers to the amount of goods or services that one unit of currency can buy. Due to inflation, purchasing power may diminish over time because rising prices effectively reduce the quantity of goods or services that can be purchased with one unit of currency. Purchasing power is also known as the buying capacity of money. In investment terms, purchasing power or buying power refers to the amount of credit a client can obtain based on the marginable securities available in their brokerage account.

Origin

The concept of purchasing power dates back to the advent of currency usage. As economies developed and currency became widespread, people began to focus on the actual purchasing capacity of money rather than just its face value. Particularly during periods of inflation, changes in purchasing power became a focal point for economists and investors.

Categories and Features

Purchasing power can be divided into nominal purchasing power and real purchasing power. Nominal purchasing power refers to the face value of money, while real purchasing power takes into account the effects of inflation. Real purchasing power better reflects the true value of money in the market. Investors typically focus on real purchasing power to assess the actual returns on their investments.

Case Studies

A typical case is the economic crisis in Venezuela. Under high inflation, the purchasing power of the Venezuelan currency plummeted, leading to a significant increase in the cost of living for residents. Another example is the stagflation period in the United States during the 1970s, where inflation and economic stagnation occurred simultaneously, leading to a decline in the purchasing power of the dollar, prompting investors to turn to assets like gold for value preservation.

Common Issues

Investors often misunderstand the impact of changes in purchasing power on their investments. A common issue is neglecting the erosion of investment returns due to inflation. To maintain purchasing power, investors need to consider inflation-adjusted returns rather than just nominal gains.