What is the relationship between inflation and purchasing power?

Inflation refers to the general rise in prices of goods and services over time. When inflation occurs, the purchasing power of money declines, meaning that consumers can buy less with the same amount of money than they could previously. For example, if prices increase by 3%, something that cost $100 will now cost $103. This scenario indicates that without a corresponding increase in income, individuals are unable to purchase the same quantity of goods and services as before, effectively reducing their purchasing power.

The concept of purchasing power directly ties into how inflation impacts consumers' economic well-being. If wages do not keep pace with rising prices, it results in a decrease in the ability of consumers to buy essential items. Consequently, while inflation may seem beneficial for borrowers by eroding the real value of debt, it generally reduces the purchasing power of average consumers, making the correct choice clear.