How does the purchasing power of money relate to the price level?

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mkoren eNotes educator| Certified Educator

There is a connection between purchasing power and the price of items. When the price of products drops, purchasing power increases. When prices are lower, people are able to buy more products with the money they have. If there is a prolonged period of lower prices, this is known as a period of deflation. Consumers tend to like a situation where their money goes farther by being able to buy more products.

On the other hand, when prices rise, purchasing power drops. People are able to buy fewer products with their money. A prolonged period of time of rising prices is known as inflation. Inflation makes it harder for people to buy items because they need more money to buy the things they want. People in debt tend to benefit from an inflationary period because the money they use to pay back their debt may buy less than when they originally got their loan.

There is a connection between the purchasing power of money and the price of items.

pohnpei397 eNotes educator| Certified Educator

Basically, there is an inverse relationship between the price level and the purchasing power of money.  The higher the price level (all other things being equal) the lower the purchasing power of money.

The reason for this is that the price level in an economy refers to a measure of the price of all goods and services in that economy.  When the price level rises, things are more expensive.  When things get to be more expensive, each dollar (in the US) is worth less.  This is because each dollar cannot buy as many goods and services as it once could.

Overall, then, the purchasing power of money is inversely related to the price level in the economy.