PURCHASING POWER: THEORY OF PARITY, LOSS, GAIN - ECONOMY - 2024

The purchasing power is the value of a currency, which manifests itself depending on the amount of services and products that can be purchased with the monetary unit. The currency can be a commodity capital, such as gold or silver, or fiat money issued by authenticated government agencies.

It is important to know this value since, under equal conditions, inflation reduces the amount of services or products that could be purchased with the same amount of money.

Source: picryl.com

For example, if someone had brought a unit of currency to a store in the 1950s, it would have been possible to purchase a greater number of items than would be the case today, indicating that the currency had greater purchasing power in The 1950s.

Traditionally, the purchasing power of money was largely dependent on the local value of gold and silver, but it was also subject to the availability and demand of certain products in the market.

Power of money and inflation

Most modern fiat currencies, such as US dollars, are traded with each other and with commodity money on the secondary market for the purpose of international transfers of payments for services and goods.

As Adam Smith pointed out, having money gives someone the ability to "command" the work of others. Therefore, to a certain extent, purchasing power is having power over other people, to such an extent that they are willing to exchange their work or products for money.

If a person's money income remains the same, but the price level increases, the purchasing power of that income decreases. Inflation does not always imply a fall in the purchasing power of money income, since the latter can increase faster than the price level.

Higher real income means having greater purchasing power, since real income refers to income adjusted for inflation.

Purchasing power parity theory

Purchasing Power Parity (PPP) is a macroeconomic analysis indicator for comparing economic productivity and living standards between different countries, comparing currencies through a 'product basket' approach.

According to this theory, two currencies are on par when a basket of products has the same price in both countries, taking into account the exchange rates, so that the exchange matches the purchasing power of each currency.

The exchange rate of the purchasing power used in this conversion is equal to the ratio of the respective purchasing power of the currencies, corresponding to their price levels.

This exchange rate is such that, for example, it would cost exactly the same amount of US dollars to buy euros and then buy a basket of products in the market, as buying the same products directly with dollars.

Thus, the same amount of goods can be purchased in any of the currencies, with the same initial amount of funds.

-Gross domestic product (GDP) and PPP

The PPP theory assumes that a fall in the purchasing power of any of the currencies due to an increase in its price level would lead to a proportional decrease in the valuation of that currency in the foreign exchange market.

Since market exchange rates fluctuate substantially, when a country's GDP measured in its own currency is converted to another country's currency using market exchange rates, it can be inferred that a country has a higher real GDP than the other country in one year, but lower in the other.

However, if the GDP of one country is converted to the currency of the other country using PPP exchange rates instead of the exchange rates observed in the market, a false inference will not be produced.

Essentially, GDP measured in PPP controls for different costs of living and price levels, allows a more accurate estimate of a nation's level of production.

Example

To better understand how GDP works combined with purchasing power parity, suppose it costs $ 10 to buy a shirt in the US, and it costs € 8 to buy an identical shirt in Germany.

To make an even comparison, the € 8 must first be converted into US dollars. If the exchange rate were such that the shirt, in Germany it should cost $ 15, and then the PPP would be 10/15, or 1.5.

That is, for every $ 1 spent on a shirt in the US, it would take $ 1.5 to get the same shirt in Germany when purchased with the euro.

Loss of purchasing power: causes

Loss of purchasing power is a decrease in the amount of goods that consumers can buy with their money. Consumers will lose purchasing power when prices increase and their income does not increase in the same proportion, or stays the same.

Causes of declining purchasing power include inflation, government regulations, and man-made or natural disasters.

An official indicator of purchasing power is the consumer price index. It is used to show how the prices of consumer products and services change over time.

Historical signs of severe inflation and hyperinflation, or the ruin of the purchasing power of a currency, have confirmed that there are various causes of this phenomenon.

Today, the effects of the loss of purchasing power are still being felt after the 2008 global financial crisis and the European sovereign debt crisis.

Germany and the first world war

Wars, which are often costly and devastating, can cause the economy to collapse, particularly for the losing country, just as Germany did during the First World War.

Due to this war, Germany experienced unprecedented hyperinflation and extreme economic difficulties during the 1920s, caused in part by the enormous amount of compensation that this country was forced to pay.

Unable to pay these damages with the suspicious Deutsche Mark, Germany printed paper notes to buy foreign currency, resulting in high inflation rates that rendered the Deutsche Mark worthless, with nonexistent purchasing power.

Gain purchasing power: causes

The gain in purchasing power is an increase in the amount of goods that consumers can obtain with their money.

The consumer gains purchasing power when prices decrease, or the income of consumers increases in a greater proportion than prices.

The main causes of the gain in purchasing power include higher productivity, technological innovation and deflation.

As an example of earning purchasing power, if two years ago laptops cost $ 1,000 and today they cost $ 500, consumers will automatically have seen an increase in their purchasing power.

If there is no inflation, the $ 1,000 now will be able to buy not only a laptop, but they will also be able to buy an additional $ 500 in other goods.

Countries with higher purchasing power (examples)

The GDP of a nation at the exchange rates of purchasing power parity is the sum of the value of all the products and services produced in the country valued at the prices prevailing in the United States in the signed year.

This is the measure that economists prefer when considering well-being per capita and when comparing living conditions, purchasing power or the use of resources in different countries.

According to 2017 data from the International Monetary Fund, based on PPP, China has the largest economy in the world right now.

-Internal purchasing power

The UK company Lottoland analyzed the purchasing power of different currencies in their respective countries and the related amount of goods or services that can be obtained in exchange. The ranking shows the purchasing power of each country.

Saudi Arabia

You will get more with the Saudi rial than with any other currency in the world. Saudi Arabia is a very rich country, thanks to its large reserves of natural resources.

Outside of major cities, the cost of living is relatively low, allowing you to get more for your money.

Switzerland

In relation to Europe, there is no greater purchasing power than in Switzerland. The Swiss use the Swiss franc and are not members of the European Union.

At the beginning of 2017, the franc and the US dollar were about the same value.

Belize

It has the third highest purchasing power in the world. This probably has a lot to do with the low cost of living of the small Central American country, allowing the purchase of many services and products at relatively low prices. For comparison, in early 2017 a Belize dollar was worth around $ 0.50.

Luxembourg

It is a small European country. Luxembourg tends to play a significant role in the financial world, as well as being known for its magnificent medieval architecture. When it comes to currency, Luxembourg uses the euro.

Australia

The currency of Australia is the Australian dollar. At the beginning of 2017, an Australian dollar was worth approximately $ 0.75 in the United States.

Germany

It is a member of the European Union and uses the euro as its main currency. In Germany, the euro has a higher relative value than in many other countries.

Denmark

It is one of the few countries in the European Union that does not use the euro. Therefore, it is not in the euro zone.

However, the krone is pegged to the euro to determine its relative value. Currently, it has a fairly high value.

Qatar

It is a small peninsula that juts out into the Persian Gulf with Saudi Arabia. Like its neighbors, it has benefited from the abundance of natural resources in the region.

The Qatari rial is roughly equal to $ 0.25 in the United States, but it has higher purchasing power.

U.S

In the United States, it is assumed that, everywhere, everything is centered on the dollar. To some extent that is true. A large number of purchasing power calculations are based on the value of the US dollar. Still, the dollar is not the most valuable currency on the planet.

Purchasing power in Latin America

Mexico

In 2018, the purchasing power of Mexicans fell by 2.5%. On the other hand, according to the National Council for the Evaluation of Social Development Policy, 41% of the population has an income below the value of the food basket.

In addition, it indicates that the value of the food basket increased 8.7% in rural areas and 9% in urban areas.

This body points out as the causes the increase in inflation in recent months and the fall in the income of Mexicans.

Due to inflation control during 2016, inflation was less than 3%. During 2017, inflation rebounded and that impact on prices reduced the purchasing power of thousands of people.

Colombia

During 2017, inflation in Colombia was 4.09%, below 1.66% of that registered in 2016.

The increase in tolls, rents, tuition and mortgage loan fees, and pension contributions, will be calculated based on inflation in 2017.

This results in greater purchasing power for Colombians, since the minimum wage increased 1.81% above inflation.

Argentina

In November 2018, workers saw their purchasing power fall by 20.6%, since in the last year salaries increased only 27.9%, facing inflation of 48.5%. The price increase that month reached 3.2%.

Venezuela

The Venezuelan has experienced a brutal contraction in purchasing power, as more and more wages are lagging behind prices. Hyperinflation has destroyed the purchasing power of the population.

The minimum wage is reported to have decreased from $ 250 a month in 1998 to just $ 1 in 2018.

The finance commission of the National Assembly reported that inflation in June 2018 reached 24,000% per year. In other words, a product bought in January for Bs 1 would cost Bs 240 in December. It is the highest inflation in the world.

The currency has lost its value more than three times and in the same period prices have almost tripled. The consequences are seen in the significant loss of purchasing power.

Chile

In 2018, the expansion of the Chilean economy reached 4%, doubling the rate compared to the previous year.

For this 2019, the outlook is that Chile will once again prosper above 3%.

According to the International Monetary Fund, the Chilean GDP per capita measured in PPP is equal to $ 25,890, being the highest in Latin America. On the other hand, the country's consumption increased by 3.7%.

Peru

It was the Latin American country that had the greatest increase in the purchasing power of its population during 2014, according to Latinvex.

This entity bases its results on the projections of the consulting firm Mercer, the International Monetary Fund, and the Universidad Torcuato Di Tella.

In 2018, the IMF estimated that Peru's inflation would reach 2.5%, while a wage increase of 5.7% was expected, providing an increase in purchasing power of 3.2%.

References

1. Wikipedia, the free encyclopedia (2019). Purchasing power. Taken from: en.wikipedia.org.
2. Wikipedia, the free encyclopedia (2019). Purchasing power parity. Taken from: en.wikipedia.org.
3. Will Kenton (2018). Purchasing Power. Investopedia. Taken from: investopedia.com.
4. Lottoland (2017). The Value Of Money. Taken from: lottoland.co.uk.
5. José Curiel (2018). The purchasing power of the Venezuelan has contracted brutally. The New Country. Taken from: elnuevopais.net.
6. Sonia Corona (2018). The purchasing power of Mexicans falls 2.5% in the last year. The country. Taken from: elpais.com.
7. Andrés García (2018). Higher purchasing power for Colombians: In 2017 inflation was 4.09%. Colombia I like it. Taken from: colombiamegusta.com.
8. Sputnik News (2019). Loss of purchasing power in Argentina was 20.6%. Taken from: mundo.sputniknews.com.
9. Tomás Pablo R. (2019). Chile is one of the seven OECD countries that grew the most in 2018. El Economista América. Taken from: eleconomistaamerica.com.
10. America Economy (2013). Peru leads the increase in purchasing power in Latin America. Taken from: americaeconomia.com.