Inflation means that goods and services are becoming more expensive. A small amount of inflation tends to be seen in a neutral or even positive light. This is because it tends to mean that people are driving up the prices of goods and services by making more purchases, which suggests that the economy is doing well. In contrast, a large amount of inflation tends to be seen by most people in a very negative light. After all, it destroys the purchasing power of their money. Something that is particularly brutal for those who were already less well-off. On a related note, the reverse of inflation would be deflation, which means that goods and services are becoming less expensive. That sounds wonderful. However, interested individuals should know that deflation also tends to be seen in a very negative light because people are causing the prices of goods and services to fall by making fewer purchases, which suggests that the economy is doing poorly. It seems that it is possible for deflation to happen for more pleasant reasons. For instance, it is possible that aggregate supply is increasing faster than aggregate demand because of technological advancements as well as other improvements in productivity. Unfortunately, that seems to be the exception rather than the rule.
How Is the Inflation Rate Calculated?
Theoretically speaking, people could calculate the general change in the prices of goods and services by looking at the prices of every single good and service that can be found out there. In practice, that is neither helpful nor practical. Instead, people calculate the change by using a basket of goods and services that is considered to be representative of the relevant goods and services as a whole. To name an example, the inflation rate that is used the most in the United States is calculated using the Consumer Price Index (CPI). It contains 80,000 goods and services that are supposed to be representative of the goods and services that U.S. consumers spend their money on. Furthermore, the CPI is a weighted basket of goods and services, meaning that different items have different weights because of their level of use. It isn't perfect, but to be honest, no measurement is. The CPI sees a fair amount of criticism. Even so, there are reasons why it is calculated the way that it is. In any case, people should have no problem calculating the inflation rate once they have the CPI for two different times. Essentially, they start by subtracting the CPI of the earlier period from the CPI of the later period. After which, they divide the difference by the CPI of the earlier period. Once people have that, they can convert the quotient into a percentage rate. If the percentage rate is positive, there has been inflation; if the percentage rate is negative, there has been deflation.
How Can You Figure Out Your Personal Inflation Rate?
The CPI is meant to represent the goods and services that U.S. consumers spend their money on. As a result, it isn't supposed to be representative of what other people in other parts of the world spend their money on. For that matter, CPI isn't very good for representing what a particular U.S. consumer spends their money on for the simple reason that most people aren't perfectly average when it comes to their spending patterns. As such, people who are curious about exactly how hard they are being hit by inflation will need to calculate their personal inflation rate. Fortunately, this is a simple and straightforward process. However, it can take a fair amount of work.
For starters, interested individuals should get their bank statements, their credit card statements, and every other document needed to figure out how they spent their money in the relevant periods. After which, they should sort their spending into categories for the sake of comparison. So, their grocery bills from the earlier period would be categorized under food spending. Similarly, their grocery bills from the later period would be categorized under food spending as well even if they went to different grocery stores. People are comparing like with like, so maintaining consistency throughout is critical. On a related note, there are some expenditures that don't occur with the same regularity as others but are nonetheless important. For those, people should convert them to the same regularity that they are using for their other expenditures. To name an example, if they pay for something on an annual basis, they can divide that by 12 if they are running calculations for a monthly basis for everything else. Afterwards, it is just a matter of plugging everything into the same formula. Once again, that would be the costs of the earlier period subtracted from the costs of the later period. Then, the difference is divided by the costs of the earlier period before being converted into a percentage rate.
People calculate their personal inflation rate for the purpose of getting a better understanding of their finances. In particular, it provides them with a better understanding of how they specifically are being affected by the general change in the prices of goods and services. Something that is very important if people are thinking about taking steps to reduce its impact on them. After all, they can't work to mitigate a problem unless they have a good grasp of the problem. Calculating their personal inflation rate is just one of the things that need to be done if they wish to do so. Of course, there are other processes that can help as well. If people are already taking out their documents for the purpose of calculating their personal inflation rate, they should also use that opportunity to run some calculations for some other things. In particular, if they haven't already done so, they should be drawing up a budget for themselves to see exactly what they are spending their money on. A personal inflation rate tells them how they are being impacted. However, a budget is how they will actually be able to figure out what they can do about the inflation that is going on by making changes in their spending.
Written by Allen Lee
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