the value of money and purchasing power

THE VALUE OF MONEY. The value of money is defined as the quantity of goods and services which a given amount of money can buy. In other words, the value of money refers to the purchasing power of money.

When a certain amount of money can buy fewer goods and services, this will mean that the value of money has fallen and this can only happen when there is a rise in prices.

But if a given amount has risen, and this can only happen when there is a fall in prices such as when a N50 note can purchase 20 cups of beans instead of 10, this means there is an increase in the value of money.

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  FACTORS THAT DETERMINE THE VALUE OF MONEY

(1) The price level: The value of money varies with the price level. If the price level increases, this would mean that a given sum of money would buy fewer goods and services.

The value of therefore falls with an increase in the: level. Note that a fall in price leads to an increase in the value of money.

(2) The supply of money and its of or velocity in circulation: When a d quantity of money in circulation inc while there is little or no corresponding increase in the available quantity of goods and services, this would mean that a larger quantity of money would purchase fever commodities.

The value of money would therefore be low. The velocity circulation of money refers to the: at which money circulates with the economy by changing from one hand to another.

When there is an increase: in the velocity of circulation of money, prices increase, leading to a lowering: in the value of money.

(3)        Inflation and deflation: It is generally known that the value of money reduces during the period of inflation while value increases during deflation.

(4)        Volume of goods and services level of production determines the volume of goods and services in an economy.

When more goods and service are available while the supply of money remains constant, the value of me increase. This is due to the fact that more commodities can be purchased given a sum of money

MEASUREMENT OF VALUE OF MONEY

The value of money as well as the nation’s cost of living is measured by the use of the price index, which is also called the index of retail prices.

A price index is a weighted average of prices and is expressed as a percentage of prices existing in a base year. As discussed earlier, the value of money is inversely related to price level.

To know the value of money, you can consider the following factors:

Currency exchange rates: The value of money can vary based on the exchange rate with other currencies.

Exchange rates fluctuate based on various factors such as economic conditions, interest rates, inflation, and market demand.

You can check exchange rates online or at financial institutions to understand the value of your currency in relation to other currencies.

Inflation: Inflation refers to the general increase in prices over time, which reduces the purchasing power of money. To assess the values of money, it\’s essential to consider the inflation rate.

Higher inflation erodes the value of the currency, while lower inflation generally indicates better value.

Purchasing power: The value of money can be determined by its purchasing power, which is the number of goods and services that can be acquired with a given amount of currency.

If the prices of goods and services rise significantly, your money\’s value decreases as you can purchase fewer items with the same amount.

Economic indicators: Monitoring economic indicators can provide insights into the values of money. Key indicators include Gross Domestic Product (GDP), employment rates, interest rates, and consumer price index (CPI).

Positive economic indicators often suggest a stronger currency and vice versa.

Market trends: Pay attention to market trends and investor sentiment as they can influence the value of money.

Factors such as political stability, economic policies, geopolitical events, and global market conditions can impact currency values.

Historical data: Analyzing historical data and trends can provide valuable information about the value of money over time.

You can review historical exchange rates, inflation rates, and economic performance to gain insights into the currency\’s value.

It\’s important to note that understanding the values of money can be complex and subject to various factors.

insights into assessing the value of money accurately.

what is an index number?

An index number is defined as a single number which measures changes in the prices of goods and prices over a given period of time.

The price index number can be determined by illustrating different items, namely Bournvita and sugar. The prices of the two items in 2012 are taken as the base year and the prices of 2013 as the current year.

By definition:

  Price in the current year

Price index      =          Price in the previous year

and the            value is expressed as a percentage by multiplying by 100%;

thus,

  • Price index of Bourvita =

Price in the current year (2013 price)

Price in the previous year (2012 price)            x          100%

  • Price index of sugar    =          2013 price

2012 price       x 100%

Example

Assuming that price of a packet of sugar was 620.00 in 2012 but rose to 630.00 in 2013. Calculate the index number

Solution

                                    Price in 2013

Index number =          price in 2012   x          10%

=          30        x          100      =          150

            20                    1

From the calculation, assuming the index of the base year is taken to be 100, it then means that the index rose from 100 to 150.

It equally means that the price of a packet of sugar rose by 5% between 2012 and 2013. It can also be concluded from the above calculation that the value of money fell by 5% between 2012 to 2013. Thus the cost of living rose in that period.

The significance of the price index is that it is used to compare the rise in the cost of living between any chosen period of time.

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