Question

Suppose you earn \(£ 1200\). You purchase only shirts, which are \(£ 10\) each, with your income every month. (a) What is the purchasing power of your income ? (b) Now, suppose your income increases to \(£ 1500\) a month but the price of shirts remains the same. Does the purchasing power of your income change ? (c) Suppose your income remains \(£ 1200\) but the price of shirts increases to \(£ 12\) each. Does the purchasing power of your income change ?

Short answer

(a) 120 shirts; (b) Yes, increases to 150 shirts; (c) Yes, decreases to 100 shirts.

Step-by-step solution

Understanding Purchasing Power

Purchasing power refers to the number of units a person can purchase with a given amount of money. Initially, we need to determine how many shirts can be bought with the current income given the price per shirt.

Calculate Initial Purchasing Power

Given an income of \(£1200\) and the price per shirt at \(£10\), we calculate the number of shirts that can be bought: \[\text{Number of shirts} = \frac{1200}{10} = 120.\] This means 120 shirts can be purchased.

Assess Effect of Increased Income

If income increases to \(£1500\) while the price per shirt stays at \(£10\), calculate the new purchasing power: \[\text{Number of shirts} = \frac{1500}{10} = 150.\] The purchasing power has increased to 150 shirts.

Assess Effect of Increased Shirt Price

With income still at \(£1200\) and the shirt price rising to \(£12\), calculate the new purchasing power: \[\text{Number of shirts} = \frac{1200}{12} = 100.\] The purchasing power has decreased to 100 shirts.

Key concepts

Exploring Income Changes

When we talk about income changes in economics, we're considering how shifts in the amount of money you earn can impact your purchasing power. Let’s start with an example: Imagine your monthly income increases from £1200 to £1500. This is an income change.
This increase means you have more money to spend. Assuming the prices of the things you buy haven’t changed, you can now buy more. With the extra £300, your disposable income has effectively increased.
Here are some things to keep in mind about income changes:

• Higher income means more flexibility in purchasing decisions because you have more financial resources.
• Income changes don't automatically mean better purchasing power unless prices of goods stay the same or decrease.

In our example, you can buy more shirts with your new income, since each shirt still costs £10. Your purchasing power has increased from being able to buy 120 to 150 shirts. This is a straight-forward demonstration of how income changes can enhance purchasing power.

Understanding Price Changes

Price changes are another crucial concept in economics. They affect purchasing power by altering how much you can buy with your existing income. Suppose that the price of shirts rises from £10 to £12. This price change decreases what you can purchase with the same amount of money.
Even if your income stays constant at £1200, the increased price results in purchasing fewer shirts than before. Let's delve deeper into how price changes work:

• When prices go up, the same amount of income buys fewer goods and services, hence reducing purchasing power.
• Conversely, if prices drop, your purchasing power increases, as you can afford more items with the same income.

In this scenario, with the new higher price of £12 per shirt, your purchasing power diminishes, allowing you to buy only 100 shirts instead of the original 120 despite having the same income. This clearly shows the impact of price changes on purchasing power.

Basics of Economics Relating to Purchasing Power

In the vast world of economics, purchasing power is a fundamental concept connecting income, expenditure, and price levels. When we examine economics, several key aspects influence how purchasing power operates.

• Supply and Demand: These are the cornerstones that determine price fluctuations in the market. High demand with limited supply often pushes prices up, impacting purchasing power negatively.
• Inflation: This is the overall rise in price levels across the economy, eroding purchasing power as your money buys less than it previously could.
• Consumer Behavior: How individuals choose to spend their income affects market trends, sometimes influencing prices and subsequently purchasing power.

Understanding these elements can help you grasp the broader economic context. Economic theory posits that maintaining a balance between income and prices is pivotal for stable purchasing power. Practical scenarios, like our shirt-buying example, help illustrate these core concepts and their effects on daily financial decisions.