Purchasing power

Purchasing power: # of products exchanged per monetary unit.

It is determined by the demand of money (# of products exchanged) and the supply of money (# of monetary units exchanged).

Price: # of monetary units exchanged per product.

Purchasing power = 1 / price.

A higher preference for saving causes a purchasing power increase and makes the society wealthier.

Monetary equation of exchange: M*V = P*Q

M = # monetary units

V = # times a monetary unit is exchanged for products per time "t"= 1 / average "t" holding a monetary unit.

P = price per product

Q = # products exchanged per time "t"

substituting:

purchasing power = Q * avg "t" holding an unit / M

Purchasing power is directly related to avg "t" holding an unit, that is, how much time savings last when maintaining an average consumption.

Basic example:

Society consisting of two members. M and Q are constant.

M = 4 gold coins

in terms of price, 1 apple = 1 fish

Alice produces 8 fishes per day and Bob 8 apples per day, so Q = 16

Alice only consumes what Bob produces and vice versa.

t = 1 day

if preference for savings = 1 day of average consumption:

Purchasing power of 1 gold coin = 16 * 1 / 4 = 4 (4 fishes or 4 apples)

if preference for savings = 2 days of average consumption:

Purchasing power of 1 gold coin = 16 * 2 / 4 = 8 ( 8 fishes or 8 apples)

A higher preference for saving forces prices to go down. Now Alice and Bob have a greater quantity of savings, while their production and consumption level is maintained.