What effect does inflation have on purchasing power?

Inflation has a direct impact on purchasing power, which refers to the amount of goods and services that can be bought with a unit of currency. When inflation occurs, the general level of prices for goods and services rises, meaning that each unit of currency buys fewer goods and services than it did before.

This diminishing ability to purchase items essentially reduces the purchasing power of money. For example, if the inflation rate is high, and your income does not increase at the same rate, you will find that you can afford less than before, even though you may have the same amount of money. Thus, inflation leads to a decrease in purchasing power, which is why the correct choice accurately reflects this economic relationship.

Understanding the implications of inflation is crucial for budgeting and financial planning, as it underscores the importance of considering both inflationary trends and income growth when assessing your financial situation.