Meanings of Purchasing Power

Purchasing power provides information about the value of money. It shows how many goods or services can be purchased for a certain amount of money. Using price indices such as the purchasing power index, it is possible to show the development of selected prices and to compare them between different regions.

  • Purchasing power indicates the amount of goods and services that can be purchased with one monetary unit.
  • The purchasing power index makes it possible to compare the purchasing power of a specific region with the national or international average.
  • If the annual rise in wages is less than inflation, purchasing power falls.

Definition of purchasing power

In economics, purchasing power is the exchange ratio between money and goods or services. It describes the amount of goods that can be bought for a certain amount of money and thus represents a measure of the value of money. This is basically variable. If the price level rises, it is a question of inflation . In the opposite case, one speaks of deflation .

The internal value and the external value are of particular importance for purchasing power. The intrinsic monetary value is determined by means of a price index. There is, for example, falling purchasing power when a person in a currency area receives fewer goods for the same amount of monetary units at a later point in time. The external monetary value, on the other hand, results from the exchange rate of a country and also takes into account the local price level. According to abbreviationfinder, CPP stands for Current Purchasing Power.

Calculate purchasing power

In order to be able to calculate purchasing power, the concept of price level must first be clarified. This is an economic indicator that indicates how many monetary units are used in a country for a shopping basket made up of selected products and services. In principle, the following applies: If the price level increases, the purchasing power decreases according to the following formula : Purchasing power = 1 / price level. The current price level, in turn, is calculated using the formula: (old price level / new price level x 100) – 100.

For example, if the price level increases by ten percent within a certain period of time, the value of money is reduced by 9.1 percent to 90.9 percent. Because of the constant counter, the development of purchasing power always depends on the percentage increase in the price level or the inflation rate. Due to its high informative value, the price level is of great importance for the economy.

The purchasing power index enables regional comparison

The purchasing power of a consumer household does not only depend on the level of the salaries of the individual members. In addition, there are significant differences between different regions. These are particularly important for the consumer goods industry. After all, there is a need to adapt the range of products to regional conditions in order not to neglect customer requirements.

The purchasing power index – also known as purchasing power index – shows how high the purchasing power of a specific region is compared to the national average. The key figure therefore relates to a federal state, a district or a specific postcode area. However, it is also possible to compare individual countries with one another. The purchasing power index is essentially calculated using wage and income statistics as well as data on state transfer payments. The standard value for the national average is always 100. The following list shows how the purchasing power index is to be interpreted:

  • Purchasing power index> 100: The area has above-average purchasing power
  • Purchasing power index = 100: purchasing power corresponds to the national average
  • Purchasing power index <100: the area has below average purchasing power

Purchasing power in Germany

The purchasing power index for Germany is the result of an annual study by the market research company GfK . In this context, purchasing power represents the population’s nominally available net income. This also includes transfer payments such as pensions or child benefit.

In Germany, the nominal purchasing power is increasing continuously. This development is based on the one hand on a stable labor market and on the other hand on rising wages in many industries. However, there are significant regional differences. In 2021, Bavaria has the highest purchasing power index of all federal states (109.0), closely followed by Hamburg (108.3). In the big cities with a population of over one million, Munich led the way (132.8). The district with the highest purchasing power is Starnberg (141.1).

The purchasing power parity shows regional differences

Purchasing power parity between two demarcated areas of the same currency area exists when products and services of a representative basket of goods can be acquired for amounts of equal value. In the case of different currency areas, purchasing power parity exists if the exchange rates of the individual currencies have the same purchasing power. In particular, this concept enables

  • To make statements about the differences in the cost of living between different countries as well
  • to compare economic variables such as gross domestic product(GDP) or the per capita income of individual countries internationally.

Loss of purchasing power due to inflation

Inflation is one of the main reasons for the decline in purchasing power. It describes the continued rise in the price of goods and services. In principle, price stability is one of the top goals of central banks. Nevertheless, a slight increase of around two percent, in contrast to deflation on the part of the European Central Bank, is expressly desired. Since the average prices rise continuously over time, there is often talk of monetary devaluation in this context. If the extent of inflation is the same for wages and prices, then purchasing power remains unchanged.