What is Purchasing Power?
Purchasing power is nothing but the buying ability of a unit of money. It is a measure of the value of a currency in terms of the goods and services that it can buy. This buying power is highly dependent on inflation. Everything else remaining the same, as the price level rises, a unit of money buys a lesser amount of goods and services and vice-versa.
A simple example will illustrate this better. Say, 20 years earlier, you father used to earn Rs. 10,000 monthly and your family ran quite well with this amount of money. But can Rs. 10,000 buy you the same standard of living today? No, and the reason is that due to inflation, in the course of these 20 years, the purchasing power of Rupee has fallen.
Purchasing power is a significant economic parameter. Consumers, investors and other economic agents are highly affected by its variation. That’s why it is a prime concern of policy makers to maintain the purchasing power of domestic currency.
What is Purchasing Power Parity?
A derived concept from purchasing power is the Purchasing Power Parity (PPP). The idea is to determine a rate at which two currencies are exchanged to keep their purchasing power same in both countries. In other words, the price of a commodity should be same in two countries when expressed in terms of a single currency.
Say, Nivea soap costs $1 in the USA. Then it should cost exactly Rs. 66 in India when the prevailing exchange rate between USD and INR is 66. If it costs say, Rs. 65 or Rs. 67 in India then the parity is lost.
This concept has significance in comparing the economic profile of two countries. However, experts challenge it on the ground that it is hard to find an identical basket of goods to compare purchasing powers of different countries.
