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What is Purchasing Power?

By Bajaj Broking Team

March 17, 2025

5 mins read

Share Market

Synopsis:

Purchasing power means the ability of money to purchase goods and services. Inflation is the most important factor that negatively affects the purchasing power of money. As the prices increase Read more..the ability of money to purchase goods or services decreases. Hence, you need to plan your finances well. Otherwise, inflation can affect purchasing power in such a manner that you may not be able to save and invest adequately for your future. Read less

Purchasing power refers to how many goods, products, or services can be bought with a specific unit of currency. Let us say that you can buy a kilo of rice for ₹ 100. Then, the purchasing power of ₹100 is that it can enable you to buy a kilo of rice.

The concept of purchasing power is of utmost importance in understanding the value of a currency. Purchasing power can decline due to inflation over a period. This is because inflation increases the price of products and services. Let us take the same example we discussed above.

If the price of a kilo of rice is ₹100 today, it is very likely that the same quantity of rice will cost more than ₹100 a year from now, which shows how inflation reduces purchasing power. Having learnt what purchasing power is, let us move further on this topic.

Importance of Purchasing Power in Personal Finance

Purchasing power is an extremely important concept from the viewpoint of personal finance, as it dictates how many goods and services you can afford in your day-to-day life. It is well-known that inflation depletes the purchasing power of money. In other words, you need more money this year to buy the same set of products and services you bought last year.

Hence, unless you consider inflation and its impact on your purchasing power, you cannot plan your finances well. So, if you understand purchasing power well, you can make smart decisions about your expenses, savings, and investments.

Suppose your research shows that inflation will be 10% in the next 12 months. Using this data, you can estimate how much you need to save and invest to reach your financial goals.

Factors Affecting Purchasing Power

If you want to learn the concept of purchasing power thoroughly, you need to understand the factors that affect it, which are explained below:

Inflation: The most crucial factor that impacts the purchasing power of money is inflation. As the prices of goods and services increase every year, the purchasing power of money falls down.
Interest rates: An increase in interest rates results in an increase in the borrowing cost of money, which causes disposable incomes to fall, thereby declining the purchasing power of money.
Currency exchange rates: Exchange rates also affect purchasing power. Suppose Indian Rupee depreciates against the US Dollar, then consumers in India will have to spend more to purchase American goods and services. Hence, a depreciating Rupee will weaken their purchasing power. Conversely, an appreciating Rupee will enhance their purchasing power.

How Inflation Impacts Purchasing Power?

Inflation negatively affects the purchasing power of money. Due to inflation, a product or service that costs a certain sum of money this year will most likely cost more next year.

In fact, hyperinflation can even destroy the value of a currency. Hyperinflation occurs when a price increase is so excessive that it is out of control. Due to hyperinflation, prices can rise by more than 50% in a month.

For example, after World War 1, Germany faced severe economic issues, including hyperinflation, which was partly due to the considerable reparations Germany had to pay.

Germany found itself unable to pay for these repatriations. Hence, it printed paper currency to purchase foreign currencies. As a result, inflation soared. The condition was so bad that the German mark became valueless, as it had no purchasing power left.

Strategies to Preserve and Enhance Your Purchasing Power

While purchasing power may decline due to inflation, you can preserve and at times even enhance it by following these strategies:

Invest in assets that can provide a higher return than inflation: You need to find assets that can provide you with a higher return than inflation over a long period. Often, shares can deliver a higher than inflation return, especially over a long period. Real estate, too, can provide inflation beating returns. However, before investing in shares, real estate, or any other asset, you should do your own research.
Spread your investments across asset classes: You should invest in a variety of investment products across different sectors and asset types. Such diversification can help reduce your portfolio risk. This is how diversification works. Suppose one investment does poorly, it is possible that another investment in a different asset class performs well, thereby lowering the overall risk.
Reduce your debt: You must try to reduce your debt, especially high-interest debt, such as credit cards. If you pay off such debts timely, you will not have to worry about how rising interest rates due to inflation can affect your disposable income. Hence, you must try to minimize your debt as much as possible.
Make the best of offers and deals available: Even when inflation is high, several brands tend to offer deals and discounts, especially around festivals, like Diwali and Holi. You should make the best of such deals to reduce your overall spend on shopping and increase your purchasing power.

Purchasing Power in the Indian Economy: A Closer Look

While the Indian economy has grown at a high rate, it has also witnessed higher inflation than developed economies. At times, inflation affects a certain section of society more than it affects another section.

For example, an Economic Times report said that city people in India are reducing their spending on a lot of products, as high inflation is eating into middle-class budgets.

Further, the report added that the reduced spending of urban dwellers has affected the profitability of the largest consumer goods firms in the country. The article cautioned that the middle class of India seems to be shrinking.

A news report by Business Standard said that inflation pushed up the cost of essential goods and services in India in 2024. The report highlighted that food inflation remained high in 2024, as vegetable prices soared. Increasing food prices caused people to reduce their discretionary spending around the time of festivals.

Hence, the retailers of home appliances and electronics witnessed a slowdown in sales.

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