What is purchasing power?

Purchasing power is the quantity of goods and services that a sum of money or income can buy. A numerical increase in income does not necessarily increase purchasing power. Income growth must be considered alongside the price changes a person faces.

How is purchasing power calculated?

1. Nominal and real income Nominal income is the monetary amount of wages or earnings. Real income interprets that amount relative to prices. If the same wage buys fewer goods, purchasing power has fallen. Comparisons should specify both the period and price measure. 2. A percentage example If income rises 20 percent and relevant prices rise 30 percent, the real change is 1.20 / 1.30 − 1, approximately a 7.7 percent fall. Subtracting the two rates is only an approximation, especially inaccurate at high rates. 3. Household baskets differ Rent, food, education and transport take different shares of different household budgets. A general consumer index tracks an average rather than perfectly representing one person’s experience. Region, household size and needs affect the comparison.

International comparisons and everyday use

4. Purchasing power parity Purchasing power parity helps compare production or consumption across economies by accounting for price-level differences. It is a statistical conversion tool, not a rate at which a bank will exchange currency. It differs from a market exchange rate. 5. Available income Taxes, mandatory payments and debt service affect the amount available for spending. Two households with identical gross incomes can have different usable resources. Public services and housing circumstances also affect living conditions. 6. Sound monitoring Compare products of equivalent quality over the same period. Smaller packages or changing quality can affect the real cost. Wage changes or exchange rates alone cannot provide a complete purchasing-power assessment.