Fundamentals

Inflation and Purchasing Power: Why the Same Money Buys Less

By Daniel Sardá · Published on September 24, 2026

6 min read1,251 words

Inflation affects more than prices: it changes what a given sum of money can buy. Distinguishing nominal from real figures helps explain a loss—or gain—in purchasing power.

Why might a budget that once filled a basket now leave some items out? One answer lies in purchasing power: the quantity of goods and services that a sum of money can buy.

When the general price level rises while that sum remains unchanged, its purchasing power falls. The number printed on a banknote or a payslip does not change, but what it represents in daily life does. That is the essential relationship between inflation and purchasing power.

The scope of the term is worth clarifying. Purchasing power may refer to a sum of money, a wage, or a household’s income. It is not the same as wealth: someone may own assets while having little income available for current purchases. Nor does it, by itself, describe well-being, which depends on many other factors.

Key idea: Nominal value tells us how many monetary units there are; real value tells us what those units can buy.

From rising prices to less purchasing power

Inflation is a general increase in prices over time. It should not be confused with an isolated rise in the price of one product. Coffee may become more expensive after a poor harvest while other prices remain stable or fall; inflation concerns the movement of a broad basket of goods and services. For a broader introduction, see what inflation is and why it destroys purchasing power.

Imagine that a basket costs 100 monetary units and costs 110 a year later. If disposable income remains at 100, it is no longer enough to buy the same basket. Nominal income is unchanged, but its purchasing power has fallen.

Now suppose income rises from 100 to 105. That is a 5% nominal increase, but prices have risen 10%. In real terms, income still loses roughly 4.5% of its purchasing power: the precise calculation is `1.05 / 1.10 − 1`. Subtracting one rate from the other gives an approximation, not the exact result.

The example also shows why it is inaccurate to say that inflation always reduces the purchasing power of everyone. If income rises faster than the prices relevant to its recipient, purchasing power may increase. The useful question is not merely how much a wage rose, but how much it rose relative to prices.

Nominal wages, real wages, and cumulative inflation

A nominal wage is the amount paid in money. A real wage adjusts that amount for changes in prices. This distinction prevents us from treating a pay rise as an improvement when it does not cover a basket’s higher cost, while also preventing the assumption that every price increase automatically harms every worker.

Another common confusion is to mix annual inflation with cumulative inflation. The annual rate compares the price level with that of twelve months earlier. A cumulative rate compares two specified points in time and incorporates the compounded effect of changes in between.

For that reason, rates over several years should not simply be added together. If prices rise 10% one year and another 10% the next, a basket that cost 100 first rises to 110 and then to 121. The cumulative increase is 21%, because the second increase applies to an already higher price level.

It is also important to distinguish inflation from disinflation. When the inflation rate falls, prices may still be increasing, only more slowly. In other words, disinflation does not mean lower prices.

Key idea: A lower inflation rate does not by itself restore lost purchasing power; the price level may remain above its starting point.

The CPI is an average, not every household’s budget

To estimate inflation, statistical offices commonly use a consumer price index (CPI). The index tracks the cost of a representative basket and gives its components different weights according to their importance in aggregate spending. This approach makes it possible to compare price movements across periods and to adjust monetary values.

But a representative basket is not the exact basket of every person. A household that spends much of its budget on rent, another that spends more on transport, and another that needs particular medicines may experience different changes even under the same official rate.

That does not make the CPI useless. It means that it answers an aggregate question: how the price of a defined basket changes on average. So-called personal inflation depends on what each household buys, in what proportions, and how it substitutes among products. In addition, the CPI and the cost of living are not perfectly identical concepts, because the latter seeks to account for changes in the spending needed to maintain a given level of utility.

The difference between an average and personal experience explains why two claims can be true at once: the official index may be correctly calculated, and a family may experience a larger or smaller increase in costs than the average.

Savings, contracts, and decisions over time

The loss of purchasing power is not confined to this month’s wage. It also affects decisions that connect the present with the future.

Money saved as a fixed amount buys less if prices rise while that amount is not adjusted. Contracts work similarly: rent, a pension, or a payment agreed in nominal terms can change in real value while the agreement remains in force. Some agreements include indexation mechanisms, but these do not automatically remove the problem. The outcome depends on the chosen index, how often adjustments occur, lags, and the contract’s terms.

When inflation is high and variable, it also becomes harder to compare prices across time, budget for projects, and agree on long-term obligations. Uncertainty matters as much as the average: households and businesses must make decisions without knowing clearly what purchasing power future payments and receipts will have.

Key idea: Monetary stability does not guarantee the outcome of every decision, but it makes the information conveyed by prices easier to read and makes planning easier.

From an institutional perspective, that predictability has value because it allows people to contract, save, and coordinate exchanges with less arbitrariness. Credible monetary rules and effective limits on discretion can help reduce uncertainty. Consumers should not be expected to bear sole responsibility for offsetting persistent inflation.

How to assess purchasing power carefully

To determine whether an income gained or lost purchasing power, compare its change with a relevant price index over the same period. It is also useful to consider cumulative inflation, not only the latest annual rate, and to remember that no average perfectly reproduces every household’s budget.

This framework avoids two opposite errors. The first is to think that a nominal increase necessarily means an improvement. The second is to conclude that everyone loses the same amount when inflation is at a given rate. In both cases, the decisive relationship is between the money available and the prices of the goods and services that money is meant to buy.

Understanding that relationship makes it easier to read a payslip, a contract, or an inflation figure. Nominal figures tell us how much money there is; real figures help answer the question that affects daily life: what can be done with it?

Sources consulted

• European Central Bank: What is inflation?
• IMF and other institutions: *Consumer Price Index Manual: Concepts and Methods* (2020)
• ILOSTAT: Concepts and definitions on wages and working time
• Banco de la República: What happens when inflation is high and variable?