How does inflation typically affect purchasing power?

Inflation refers to the general increase in prices of goods and services over time. When inflation occurs, the purchasing power of money decreases, meaning that consumers can buy fewer goods and services with the same amount of money than they could before.

For instance, if the inflation rate is 3%, items that previously cost $100 would now cost $103. If wages do not increase at the same pace as inflation, individuals will find that their money does not stretch as far. Therefore, inflation effectively reduces the amount of goods and services that can be purchased for a given amount of money, leading to a decline in purchasing power over time.

Understanding this relationship is critical, particularly for effective personal finance planning, as it underscores the importance of investments and saving strategies that can outpace inflation to maintain or enhance purchasing power in the long term.