How does inflation affect purchasing power?

• A. It increases purchasing power
• B. It maintains purchasing power
• C. It has no effect on purchasing power
• D. It erodes purchasing power

Answer: (D)

Inflation erodes purchasing power because it leads to an increase in the prices of goods and services over time. When prices rise due to inflation, each unit of currency buys fewer items than it did before. This means that if someone’s income does not increase at the same rate as inflation, they will find that they cannot afford as much as they could previously with the same amount of money.

For example, if the inflation rate is 3% per year, a basket of goods that costs $100 this year would cost $103 the next year. If a person’s salary remains constant, they can only purchase less of that basket of goods over time, effectively reducing their purchasing power. Therefore, as inflation occurs, it diminishes the value of money, making it necessary for consumers to spend more to maintain their previous level of consumption.