How does inflation affect purchasing power?

Inflation decreases purchasing power over time, which means that as prices rise, the same amount of money can buy fewer goods and services. This effect occurs because inflation reflects an increase in the overall price level in the economy. When inflation is present, consumers need to spend more money to purchase the same items they could previously buy at lower prices. Thus, if someone has a fixed income or amount of money, they will find that their purchasing ability diminishes, making it more expensive to maintain the same standard of living.

For example, if the inflation rate is 3%, a product that costs $100 today will cost $103 next year. If a person's income remains the same but prices increase, they effectively have less purchasing power than before, as their money does not stretch as far. This concept underlines the importance of considering inflation in financial planning and budgeting, as it directly impacts how much consumers can afford to buy over time.