Inflation, Deflation, and Purchasing Power by Omkar Abhyankar

 In this article, we will be observing how prices can change over time and how those changes can affect the people of an economy. Overtime, prices of goods and services can rise or fall. When there is a general rise in the prices of goods and services economists call this phenomenon an “inflation”. When there is a general fall in the prices of goods and services economists call this phenomenon a “deflation”. “Purchasing power” is the ability of consumers to purchase a good or service. Let’s observe how inflation and deflation can affect a consumer’s purchasing power (the ability for a consumer to purchase goods or services). During inflation, costs are rising which makes it more financially difficult for consumers to purchase goods and services and hinders consumers’ ability to make purchases thereby decreasing consumer purchasing power. If the cost of purchasing a gallon of milk was once $2 and now rose to $5, purchasing that gallon of milk now would be more financially difficult since the price is more costly. This means that the consumers’ purchasing power would decrease since their ability to purchase a gallon of milk worsened. During deflation, costs are decreasing which makes it financially easier to purchase goods and services. This fosters consumers’ ability in purchasing goods and services thereby increasing consumer purchasing power. If the cost of purchasing a notebook was once $10 and now the price fell to $3, purchasing that notebook at the current price would be more financially better since it is now less expensive essentially meaning that the consumers’ purchasing power has increased since their ability to purchase a notebook fostered.

Now let’s observe how inflation and deflation would affect those who lend money and those who borrow money. Suppose a lender lends $55 to a borrower so that the borrower can make some purchase. Suppose prices rise and the economy is faced with inflation. Now, when the borrower pays the lender back, the lender can make fewer purchases with the $55 since all goods and services are more expensive now. As a result, we notice that from this exchange of money, the lender did not benefit since the lender’s ability to purchase goods and services after receiving back the $55 had diminished. In other words, receiving back the $55 during the inflation would have been the same as receiving less the $55 before prices had risen since those $55 cannot purchase as much as they were once able to. On the contrary, the borrower benefited from this exchange because the borrower was able to make many purchases with the $55 before the inflation struck and before his power to purchase goods with the $55 had decreased. Suppose instead of inflation, a deflation struck the economy. Now once the lenger receives back his $55, those $55 will purchase him more goods and services than they once did. While the borrower would not have benefited since those $55 prior to the deflation would not have allowed him to purchase as many goods. It is important to note that these inflations and deflations could be unanticipated. Therefore the lenders and borrowers would not have known how the prices would change. To combat this problem, typically interest is added upon this exchange of money. We will further talk about this in future articles when we dive deeper into interest rates. In the next article, we will explore how economists calculate inflation and measure changes in the prices of goods.