purchasing power

Examples of purchasing power in the following topics:

• The Costs of Inflation

  • The costs of inflation include menu costs, shoe leather costs, loss of purchasing power, and the redistribution of wealth.
  • Each dollar has less purchasing power with inflation.
  • Purchasing power can be maintained if wages increase exactly at the rate of inflation, but this is not always the case.
  • When wages increase less than the rate of inflation, people lose purchasing power.
  • When prices are rising quickly, people will buy durable and nonperishable goods quickly as a store of wealth, to avoid the losses expected from the declining purchasing power of money.

• Real Versus Nominal Rates

  • The real exchange rate is the purchasing power of a currency relative to another at current exchange rates and prices.
  • A measure of the differences in price levels is Purchasing Power Parity (PPP) .
  • The concept of purchasing power parity allows one to estimate what the exchange rate between two currencies would have to be in order for the exchange to be on par with the purchasing power of the two countries' currencies.
  • Using the PPP rate for hypothetical currency conversions, a given amount of one currency has the same purchasing power whether used directly to purchase a market basket of goods or used to convert at the PPP rate to the other currency and then purchase the market basket using that currency.
  • Purchasing Power Parity evaluates and compares the prices of goods in different countries, such as groceries.

• Growth in the Rest of the World

  • The purchasing power expanded for 145 markets and contracted for two.
  • The purchasing power increased for 148 markets and contracted for three.
  • The purchasing power increased for 180 markets.
  • The purchasing power contracted for 79 markets.
  • The purchasing power increased for 169 markets and contracted for 14.

• Finding an Equilibrium Exchange Rate

  • Purchasing power parity is a way of determining the value of a product after adjusting for price differences and the exchange rate.
  • The concept of purchasing power parity is important for understanding the two models of equilibrium exchange rates below.
  • Like purchasing power parity, the balance of payments model focuses largely on tangible goods and services, ignoring the increasing role of global capital flows .

• Defining Inflation

  • Consequently, inflation reflects a reduction in the purchasing power per unit of money – a loss of real value in the medium of exchange and unit of account within the economy.
  • The decrease in purchasing power means that inflation is good for debtors and bad for creditors.
  • Since debtors usually pay back loans in a nominal amount, they want to give up the least purchasing power possible.
  • Conversely, creditors don't like inflation because the money they are getting paid is can purchase less than if there were no inflation.

• Applications of Principles on Consumer Choices

  • This creates a relative buying power, which will play a substantial role in the quantity of goods purchased.
  • Predicting consumer choice requires inputs on consumer purchasing power and the goods in which they are deciding between.
  • In the substitution effect, a lower purchasing power will generally result in a shift towards more affordable goods (substituting cheaper in place of more expensive goods) while a higher purchasing power often results in substituting more expensive goods for cheaper ones.
  • This translates to the graph above as the consumer makes choices to maximize utility when comparing the price of different goods to a given income level, substituting cheaper goods and more expensive goods dependent upon purchasing power.
  • This two-part graphical representation of the substitution effect identifies the relationship between the price of a given good and the quantity purchased by a given consumer.

• Impact of Income on Consumer Choices

  • One of the central considerations for a consumer in deciding upon their purchasing behaviors is their overall income or wage levels, and thus their budgetary constraints.
  • These budgetary constraints, when applied to a series of products and services, can be optimized to capture the most utility for the consumer based on their purchasing power.
  • These differences in quantity reflect the increase or decrease an a given individual's purchasing power, thus the income effect could be summarized as the increase in relative utility captured by a consumer with more monetary power.
  • That is to say that an increase in income will not necessarily result in an increase in quantity for the inferior good, as the consumer derives minimal utility in purchasing the inferior good compared to other goods.
  • An example of this would be like purchasing an automobile and car insurance, the consumption of one requires the consumption of the other.

• Willingness to Pay and the Demand Curve

  • Purchasing Power: Demand is measured based on a person's willingness to buy under the prevailing circumstances.
  • Ability to Decide: The individual must be able to choose to make a purchase.
  • For example, an underaged person may not be permitted by law to purchase cigarettes.
  • That person might want the cigarettes and can afford to purchase them, but since it is against the law for him to purchase it, there is no demand.
  • However, since the family still need to eat a certain amount of calories each day and bread is still the cheapest option, they will purchase more bread to make up for the food they aren't purchasing and consuming.

• Introduction to Firms with "Market Power"

  • The existence of market power is tied to the demand conditions the firm faces.
  • Market power is the ability to have some control over the price of the good offered for sale.
  • Note that when the seller selects a price (price maker) the demand function determines the quantity that will be purchased.
  • The conditions of entry or barriers to entry (BTE) are also important determinants of market power.
  • Monopoly is the market structure that is usually associated with the greatest market power.

• What Taxes Do

  • Necessarily, taxes raise the price of purchasing the good or resource for firms and consumers.
  • In the United States, Congress has the power to tax as stated in The United States Constitution, Article 1, Section 8, Clause 1: "The Congress shall have the Power to lay and collect Taxes, Duties, Imposts, and Excises to pay the Debts and provide for the common Defense and general Welfare of the United States. " This power was reinforced in the Sixteenth Amendment to the Constitution: "The Congress shall have the power to lay and collect taxes on income, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration."
  • Individual states also have the power to tax as do smaller government entities such as towns, cities, counties, and municipalities.
  • Sales taxes are borne by the consumer when s/he purchases certain goods.
  • For example taxes on cigarettes are meant to dissuade purchase due to the inherent health implications of smoking.