What Is Inflation?

Do you ever feel that the price of goods you are buying keep rising while your income seems to remain the same? We can actively work to increase our income to fight this, but the price increase on many goods is beyond our control. That price increase is due to inflation, or “the sustained increase in the general level of prices for goods and services”. It is normally measured as a percentage and the amount is usually across an entire year. Every time inflation increases you get slightly less “goods” of whatever you are purchasing for the same amount of money. So if you were getting 8 of an item for $1.00 last year, now you may only be able to purchase 7.5 of that item for the same $1.00.

But how exactly is this inflation rate calculated? Just because gas prices are more or less expensive doesn’t mean that the same thing happened with milk and other goods. The government uses a “basket of goods” also known as the consumer price index to calculate the difference in prices over the cost of time. They take the average of hundreds of products and goods at one point in time, and then recalculate that same basket at a later time. The basket itself is also weighted based on the amount that the average customer is purchasing as well. The average person is not spending more on eggs than they are on gasoline, so the basket is weighted appropriately for that. Makes sense, right?

Unfortunately things do not work as perfect in real life, and the basket of goods is always changing. We aren’t still huddling around a radio every night to listen to our favorite programs, and many people aren’t even watching their favorite programs on a television anymore. Houses have slowly increased in size in time, and now a cell phone and internet connection is considered a necessity. While certain staples are easy to calculate an average, it makes life harder when the goods themselves in the basket are changing too.

The basket tries to take an average standard of living from one period of time and then compare it to the average standard of living at another period of time, so you see how things can really get complicated here. The “average” standard of living may also change, and everything in the basket itself is subjective. This is one of the reasons you will see a lot of controversy around inflation in general, with many others calculating their own inflation and stating how it is higher/lower than what the government reports.

The above examples all deal with price inflation, but there is also simply monetary inflation. This happens when the money supply increases and there is more currency available. When everyone is given more money, it simply becomes less valuable. Just because you added some zeros to the amount of your amount, so did everyone else in that case!

Many people consideration inflation to be a bad thing, but it’s actually considered a sign that the economy is growing. The important part is that your wages should be rising faster than inflation. If that is not the case, then inflation is not a good thing for your situation! This is why it’s extremely important to put your money to work for you, so that you are not losing actual value in your money. If you’re earning less than the rate of inflation – you are losing spending power.

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