Definition of Purchasing Power

Have you ever wondered what purchasing power is? It is a term that gets thrown around quite a bit, especially in economic circles. Yet, it is a concept that affects everyone, from the street vendor to the CEOs. Purchasing power, in its simplest form, refers to the quantity of goods or services that one unit of a particular currency can buy. Imagine you're holding a ten-dollar bill in your hand. The amount of goods or services you can exchange for that ten-dollar bill is its purchasing power.

Calculating the purchasing power

If not yet one day you will hear your parents or your grandparents claiming that Oil, soda, sugar, and other commodities are more expensive than it was at a young age do not laugh at them because inflation these days has reduced the value of the country currency let an example to Rwandan francs. This means that the purchasing power of the goods and services of parents or grandparents has gone down since their money can not afford the same quantity as it was before. referring to the inflation forecast, firms can calculate their purchasing power to predict their operation cost and profit.

The purchasing power is calculated based on the Consumer Price Index (CPI) data collected by the Bureau of Statistics of any country in Rwanda that bureau is called the National Institute of Statistics of Rwanda. In February 2010 the CPI was 84.9 while in February 2024 CPI was 187.6 so by dividing the base year by the later year and then multiplying by 100 to get the CPI change during that period: 84.9/187.6*100 = 45.26 percent To get the percentage change we take 100 - 45.26 = 54.74 to interpret this coefficient that means 54.74 percent is a Purchasing power reduction of Rwandan franc in February 2024 in comparison of February 2010.

How do we apply for Purchasing power?

The above calculations are not enough until we do the inverse of the same value to check how much Rwandan francs you need to buy the same quantity of goods or services in 2024 in comparison to 2010. so let's apply this: (187.6/84.9)*RWF1= RWF2.21 this is to show you will need RWF2.21 to buy a commodity that cost RWF1 in 2010.

In addition, for a better understanding of this calculus let's take a typical example for example if in 2010 we needed RWF1000 to buy 1kg sugar it required RWF2000 to buy the same quantity of sugar.

Factors Affecting Purchasing Power

But it is not as straightforward as it sounds. The purchasing power of money does not remain constant. It fluctuates, and it does so due to several factors. Inflation is one of the most influential factors. When inflation rates rise, the purchasing power of money falls. Thinking in practical terms, this means you're able to buy less with the same amount of money.

Impact of Inflation on Purchasing Power

A classic example? Think about a trip to the grocery store. If inflation is high, you might walk out with fewer items in your cart than you would have a year ago, even though you spent the same amount of money. This is the erosion of purchasing power in action.

Impact of Deflation on Purchasing Power

But it is not all doom and gloom. At times, the purchasing power can also increase, especially in situations of deflation, when prices of goods and services decrease. In such scenarios, your money can buy more than it used to.

Influence of Purchasing Power on Economies

Purchasing power is not just a concept that affects individuals. It also has a profound impact on economies at large. It influences the economic decisions of businesses, government policies, and even international trade. Understanding purchasing power is key to understanding the dynamics of an economy.

Recap of Purchasing Power

So, to recap, purchasing power is the value of a currency reflected in the amount of goods or services it can buy. It fluctuates, primarily due to inflation and deflation. When inflation is high, purchasing power goes down. When deflation occurs, purchasing power goes up. And it's a key concept in understanding economic dynamics.

Conclusion

So the next time you hear the term "purchasing power," you'll know exactly what it means. It is not just an economic term. It reflects the value of your money and its ability to buy goods and services. It's a concept that has a direct impact on your daily life, whether you're buying a cup of coffee or planning your retirement.

Author: Donald Masimbi