What Is Purchasing Power?
The purchasing power of two individuals is often evident at a grocery store check-out. While a wealthy attorney's cart may be full of organic eggs, wine, and other expensive items, a maintenance person's grocery cart is likely stocked with cheaper necessities. Similarly, some countries import enough food for their citizens whereas citizens of other countries suffer from starvation. This inequality in the ability to purchase goods reflects different levels of purchasing power.
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Definition
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D.R. Charmichael and Ray Whittington define purchasing power in their book "Accountants' Handbook: Financial Accounting and General Topics" as the ability of countries or individuals to purchase goods and services with a unit of money. Weak purchasing power means a limited capacity to purchase goods and services whereas strong purchasing power indicates an ability to buy many goods and services easily. At the individual level, purchasing power is primarily determined by income. On a global level the value of a nation's currency determines its economic purchasing power.
Considerations: Income
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Individuals with large quantities of money have strong purchasing power. Simply put, wealthier people have the ability to procure more goods and services than the poor do.
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Considerations: Currency Value
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The value of a country's currency is tied to its purchasing power. The comparison between the values of two currencies is called "purchasing power parity." For instance, if one British pound can buy two bars of chocolate whereas a U.S. dollar can purchase only one, the British pound has greater purchasing power. The currency with greater purchasing power is deemed as the "stronger" currency while the lesser is termed "weaker." Countries with a stronger currency can buy more goods from overseas whereas countries with a weaker currency can export more goods because the products are often cheaper.
Benefits
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Strong purchasing power yields benefits to individuals and governments alike. Wealthy individuals have the opportunity to own several shares of stock and influence company policy, and strong purchasing power also allows them to finance a political campaign and increase the likelihood of the candidate winning.
If a country's currency has strong purchasing power, the country can import many goods and services for a low price. However, countries must ensure they do not run a high trade deficit as a result of buying too many imports. The United States dollar, for example, is a strong currency and therefore buys many goods from countries with a weak currency, such as China. Although the U.S. uses its strong purchasing power to buy many goods, the flip side is the massive trade deficit from spending too much and not exporting and selling enough goods.
Trends
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A single dollar's purchasing power has decreased substantially in the past 100 years. The U.S. Bureau of Labor Statistics notes that the value of one dollar from 1913 is just 5 cents in 2010. This is evident by the price of goods: Whereas a loaf of bread might have cost 2 cents in the early 1900s, the cost today is a hundred times greater. The adjustments in the minimum wage and bank interest rates both account for this decline in the purchasing power of the dollar.
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References
- Photo Credit One Dollar - variations of Crumpled dollar image by PaulPaladin from Fotolia.com
