Describe purchasing power while also providing an example of decreased purchasing power.
The correct answer and explanation is:
Purchasing power refers to the amount of goods or services that a unit of currency can buy. It is influenced by various factors, such as inflation, interest rates, and economic conditions. When prices of goods and services rise due to inflation, the purchasing power of money decreases because the same amount of money now buys fewer items.
For example, consider a person who used to spend Ksh 100 to buy 10 loaves of bread. If inflation causes the price of each loaf of bread to increase from Ksh 10 to Ksh 15, the purchasing power of Ksh 100 has decreased. Now, with Ksh 100, the person can only afford to buy 6 loaves of bread instead of 10. This reduction in the quantity of goods one can purchase with the same amount of money is an example of decreased purchasing power.
Decreased purchasing power is most commonly associated with inflation, where the cost of living rises while wages may not increase at the same rate. This creates a situation where people can no longer afford the same standard of living, leading to a decrease in their quality of life. For instance, if a person’s salary remains the same, but the prices of everyday items, such as food and fuel, increase, they may have to cut back on their expenses or sacrifice other goods or services to maintain their lifestyle.
In extreme cases, prolonged inflation or economic instability can lead to a severe loss of purchasing power, impacting both individuals and the broader economy. This can result in a vicious cycle where businesses raise prices in response to increased costs, and consumers’ ability to buy goods continues to decline.