What is purchasing power?

We explain what is the purchasing power, its relation to inflation and salary. In addition, examples and what is the minimum wage.

  1. What is purchasing power?

The purchasing power (or purchasing power) is the amount of goods and services that can be purchased with a given sum of money , depending on the type of currency and market prices.

The greater the amount of goods and services that can be acquired with that sum of money, the greater the purchasing power. This power has to do with the value of the currency and not with the amount of bills.

Individuals, companies and countries use their money to meet needs. The relationship between the price they pay and the amount of a given currency they own corresponds to their purchasing power. That amount of money is conditioned by the rate or exchange rate, for example, with respect to the dollar.

The purchasing power is usually used to measure the level of wealth of a person or an entity over a period of time . The purchasing power decreases with increasing inflation and the cost of living, so it is directly related to the consumer price index (CPI) of the market.

  1. Inflation and purchasing power

Inflation is an economic imbalance process between supply (production) and demand (acquisition), which causes a generalized and increasing increase in the price level in the market. A loss of the value of the currency is generated, that is, the money is worth less because the currency lost its nominal value against other stronger currencies.

The types of inflation can be:

  • Latent or repressed. It occurs when governments establish price controls, which prevents market indices from reflecting reality.
  • Slow. It occurs over a prolonged period with a low and stable inflation rate, which allows future projections.
  • Hyperinflation. It occurs when prices rise steeply and steadily, causing uncertainty in the economy in the short term.
  • Stagflation It occurs with constant price growth along with a stagnation or decrease in the country’s production.

During an inflationary process, the imbalance between the supply and demand of money occurs for two main reasons :

An excessive increase in the money supply:

It means that there is an overproduction of banknotes that circulate in the market, whose total value exceeds its support in the banking system reserves. Money in itself is not synonymous with wealth, it is an exchange mechanism, therefore, printing more bills does not generate profits for the country. Wealth is the result of man’s action on the means of production , and a country that develops its productive capacity can generate greater profits.

For example, if a country produces goods and services worth $ 1,000,000, it must print money with a total endorsement or nominal value of $ 1,000,000. If you print twice as many bills, it means that those goods and services represent a total value of 2,000,000, that is, the currency has been devalued and is now worth less than before instead of representing a greater wealth.

A sudden decrease in the demand for money:

It means that there was a loss or leakage of the money in circulation. It can happen, for example, when citizens distrust the economy of their country and decide to extract their savings from banks , or when investors distrust, close their businesses and stop producing in the country (this generates unemployment and decreased production local currency entry).

Since money in itself is not synonymous with wealth, when it goes out of circulation in the market it is no longer an “active medium of exchange” that could generate greater production capacity.

A ‘cost inflationary spiral “in which producers speculate (due to lack of confidence in the local economy) and increase prices, while wages generated workers remain the same. This makes the price of goods and services increase but the amount of money circulating in the market is reduced.

  1. Difference between salary and purchasing power

salary salary purchasing power
Some workers do not receive a fixed salary but a salary for days worked.

The salary and salary are remunerations that workers or professionals must receive from the employer, in exchange for their work or service. Although both terms are used as synonyms, from accounting they have differences.

  • Salary : It is a sum of money that an employee receives in return for their services and is established based on a fixed amount that depends on the number of days worked over a period of time.
  • Salary : It is a fixed remuneration for a particular job, previously agreed between the worker and the employer. Unlike salary, the salary does not include discounts for holidays, licenses, vacations, etc.

The remuneration an employee receives is determined by the supply and demand of that type of position, the level of training and experience required, among other factors. In countries with unstable economies, the agreed remuneration amount may present gradual increases to match inflationary increases.

When sudden inflation or hyperinflation is generated , salary increases cannot be enough to compensate for market increases. There is a loss of purchasing power, that is, it reduces the purchasing power that the individual has with that salary .

In the concrete experience of the worker, this difference is perceived in that he charges the same amount of money or a little more, but every time he can buy less quantity of goods because that money lost nominal value.

  1. Example of purchasing power

An example of purchasing power is a person who has a monthly salary of $ 10,000 and spends about $ 3,000 per month on warehouse products. Suddenly, there is a generalized price increase that grows month by month and, after 6 months, the person spends $ 5,000 to buy the same amount of warehouse products that he used to buy.

During those six months he continued to receive the same salary of $ 10,000, which means that his purchasing power declined because his salary did not increase at the rate of rising market prices . Receiving the same amount of salary, now the person spends a greater percentage of their money to acquire the same amount of goods as before.

  1. minimum salary

The minimum wage is the stipulated basic amount that any person must receive for performing a job during a full working day.

It must be sufficient for a formal worker to have a purchasing power to be able to cover, on a monthly basis, his basic expenses and provide his family with the indispensable conditions for a decent life. The minimum amount varies according to the legislation of each country and is susceptible to inflationary variations and the value of the local currency.

The fact of establishing a minimum wage aims to protect workers against the payment of extremely low wages and ensure a fairer distribution. In addition, the designation of a minimum wage should act as a complement to other social and employment policies , in order to be a possible way to overcome poverty.

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