What is Purchasing Power and Why is it Important?
At its most basic, purchasing power translates into the amount of goods or services you can buy based on a standard monetary unit. In the U.S. this is often expressed in terms of how much a dollar can buy.
Credit and purchasing power
A number of factors can influence your purchasing power, including your credit health. Typically, those with higher credit scores can obtain better rates and terms on everything from credit cards to auto loans.
For example, an individual with a high credit score might obtain a loan on a $32,000 car at an APR of 3.00%, for 48 months and a $708 monthly payment. Someone with a lower credit score might obtain a loan for the same amount and term at an APR of 5.00% for a $736 monthly payment. As you can see, the stronger your credit, the more flexibility you have when it comes to your spending power.
Inflation and purchasing power
Inflation, which is a decrease in purchasing power, also has an impact. A couple of general theories play a role.
Supply and demand
In general, this theory says that prices go up when demand exceeds supply and drops when supply outstrips demand. Think of the millions of baseball fanatics compared to the finite supply of game tickets. You can be reasonably certain those box seats for sale online won’t be selling for face value. Likewise, those movies gathering dust in the bargain bin at the local big-box store aren’t flying off the shelves even priced as low as $1 — a clear case of supply far exceeding demand.
This is the concept that companies create inflation by raising prices to offset costs and operating expenses to stay profitable. And, depending on the product, demand might stay relatively the same whether prices rise or fall. Take gasoline, for example. Barring seasonal and holiday spikes, the demand for gas remains more or less unchanged even when prices go up. Why? Because people need their cars for their daily lives, and cars need gas whether the price is high or not. So, when the gas station raises the price of a gallon of gas because they need to offset the cost they pay for it, the average driver may grumble, but says ‘filler up’ anyway.
Why purchasing power matters
Purchasing power is important as it generally affects the amount of goods or services you can afford. From lending rates to investments to how much car you can purchase for your money, it’s definitely something to keep top of mind when making important financial decisions.
"Economic Research and Data." February 28, 2017, Board of Governors of the Federal Reserve System website.
"Everyday Economics" series. 2017, Federal Reserve Bank of Dallas website.
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