Purchasing power of money: concept, levels, inflation impact and financial implications

2024 Author: Henry Conors | [email protected]. Last modified: 2024-02-12 02:39

The purchasing power of money is an important point in financial education for every person who wants to get their affairs in order and understand the workings of the money mechanism in order to achieve personal success and prosperity.

Introduction

During the evolution of the development of types and forms of money, the question of their value came to the fore. It can rightly be considered the most difficult in economic theory in general, and in particular in the theory of money. After loans that do not have their own intrinsic value established themselves as the dominant form, this issue became even more complicated. After all, how was it before?

The value of full-fledged money depended on the product that performed its role. Thanks to this, the trust of market participants was ensured. And they accepted all payments. When gold was demonetized (it lost its monetary functions), a completely different situation arose. And it's become even more relevant.understand the purchasing power of money. Briefly, this is the amount of goods and services that can be purchased for one unit of them.

How is the current situation?

Current carriers of monetary functions have no intrinsic value. But they are accepted when paying for real values. That is, they have real value. This situation can be explained by the fact that all types of modern money are debt obligations of certain subjects of a market economy. Difficult to understand? Let's look at a small example.

Banknotes and coins are debt instruments issued by the central bank. Behind them is the economy of entire countries. Deposit money is an obligation of commercial banks, bills are issued by enterprises and other commercial structures. It should be noted that there is considerable risk associated with the purchasing power of money.

On what is trust built?

The following factors contribute to this:

1. The economic potential of the issuer (the one who organized the issue).
2. Previous experience of market entities in using this money in the process of economic turnover.
3. Implementation by the state of such a monetary and economic policy that would exclude inflationary expectations among market participants and a decrease in the level of confidence in the future.
4. Formation of a system of guarantees for checks and bills.
5. Providing paper notes and coins with legal tender status, preventing the lender/seller fromstop taking them.
6. Formation of a system of regulation, supervision and insurance in the banking sector.

Providing credit for credit (default) money and allowing it to give a specific form of value known as purchasing power.

Specific relationship

The purchasing power of money is not a constant indicator. It may change. The fall in the purchasing power of money is called inflation. Growth is deflation. The set of goods that can be purchased with a unit of money depends on the level of their prices. So, the higher they are, the less you can buy and vice versa.

Thus, there is an inverse relationship between the cost of credit money and the price level. In this case, the change is carried out under the influence of time. This is connected directly with the mechanism of formation of funds, as well as their manifestation as finance and as capital. Interest plays a big role in this. So they call the price of money as capital.

There is one more thing you need to know. This is the opportunity cost of money. What does she represent? Just as the value of goods can be measured in terms of money, so finances are measured in terms of the products and services they allow you to purchase. This makes deflation/inflation and the purchasing power of money inextricably linked.

About special indicators

They are used to determine the purchasing power of money. For example, these are wholesale andretail prices. In the first case, this refers to the value paid by enterprises and organizations, and in the second case, the population in the framework of ordinary trade for their own use. True, the calculation of such indices is not an easy task. After all, they show changes not for individual goods, but for their totality.

That is, the indices indicate the general level of prices. For example, the retail of 1990 in relation to 1985 (it is taken as the base) was 110. That is, there was an increase of 10% (110-100=10). If the index value were 95%, then this indicates that there would be a 5% drop in prices.

Cost of Living Index

Shows the prices of consumer goods and services. Calculating it is even more difficult than the previous one. Initially, they make up the so-called consumer basket. So called a set of basic goods and services consumed by the population. It is calculated for each product group.

Then, through a survey, determine how much each product accounts for in the family's consumer spending. The overall index is found as a weighted average for each group of consumer products, that is, taking into account their share.

Value change processes

There are two of them - inflation and deflation. It should be noted that the first option in our world is much more common than the second. In this regard, the quantity theory of money is important.

Its founder is considered the sixteenth-century French thinker Jean Bodin. It was he who was one of the first to notice that in hisThe increase in the influx of silver and gold into Europe from the New World led to the fact that the prices of these precious metals fell. And at the same time, the cost of everything else has risen. But in its modern form, the quantity theory of money was introduced by the economist Irving Fisher. It was he who formulated the equation of exchange.

In his work "The Purchasing Power of Money," Fisher wrote that the supply of credit notes, multiplied by the velocity of their circulation, is equal to the sum of the costs that go to all goods and services sold. When this statement is extrapolated to the entire economic life, one well-known statement emerges. Namely: the supply of money determines the price of goods. That is, it simply cannot be that the purchasing power of money increases during a period of inflation.

Development of the theory

From the above conclusion, a whole concept was developed, which is now known as monetarism. Its most famous representative is Milton Friedman. He drew an even more far-reaching conclusion from the quantity theory of money. He formulated and popularized that the government should only be concerned with regulating the money supply. And this is where their intervention in the economy should be limited.

This wording has a very rational economic background. Thus, the larger the national product created in the country, the higher the amount of money should be in circulation. After all, finances are essentially a reflection of products. When the physical quantity of the available commodity increases, the money supply must be increased andvice versa.

Let's say a word about inflation

And now let's move on to the most interesting in our conditions. The purchasing power of money tends to fall in conditions of inflation. At the same time, the mass of money that is in circulation turns out to be extremely sensitive in relation to the price level. Therefore, whether we like it or not, in this case we have to act in a proportionate way. Failure to comply with this rule can lead to various failures in the functioning of the entire commodity-money system.

As an example, we can cite the situation in Russia, which developed in the first half of 1992. Then began the liberalization of prices. In a few months, both wholesale and retail increased by about five times. The purchasing power of money during the period of inflation fell by the same amount. But here the mass of credit papers has increased only two or three times. Because of this, there was an acute shortage of money.

So the enterprises did not have enough funds to pay wages, make payments for the supply of materials and for the sale of finished products. Because of this, high-denomination banknotes had to be urgently put into circulation. The amount of cash was sharply increased, cashless payments were facilitated, mutual offsets of debts of various enterprises were allowed, that is, a lot was done to normalize circulation.

Features of inflationary processes

When they talk about the mass of finance, thenimply without/cash. The influence of inflation on the purchasing power of money is carried out not only through the issue, but also through changes in the amount of funds in bank accounts. The second option affects the amount of finance that can be spent in the absence of accounts. Additional funds are obtained in this case not due to revenue and income, but through loans, subsidies and subsidies. With adequate use of these financial instruments, this allows you to keep the situation afloat.

If you cross a reasonable line, then the change in the purchasing power of money manifests itself after a certain time. The more marked the state has taken, the sooner and stronger it will make itself felt. Moreover, it depends not only on the inclusion of the printing press, but also on regulation. From the above equation of exchange, it turns out that the amount of money needed to circulate is inversely proportional to the speed of their movement from one person to another.

About the speed of finance

The higher the velocity of circulation, the faster money runs. Accordingly, when carrying out commodity exchange operations, you can get by with a smaller number of them. There are different ways to speed up cash flow and increase the velocity of circulation. For example, reducing the duration of banking operations, which are the transfer of finances.

Improving the efficiency of financial and credit institutions also has a positive effect on this indicator. It was for these reasons that the speed was increasedfunctioning of modern banks, which allows you to get by with several days, and in fact, even a few minutes for work. But keep in mind that velocity refers to income. Don't be fooled by the idea that increasing your spending rate will increase your we alth. First of all, it is necessary to work on the growth of income, to create real value faster, to earn more. Only this way can lead us to prosperity.