Newbie Lesson - What is Inflation?


Inflation represents how prices change over time. Prices for goods and services can always change. Some prices rise, some prices fall.

So, how is inflation calculated?

To calculate inflation, we need to understand what is a basket of goods.

A basket of goods is a list of products we all use. Some products are more relevant than others.

Here are some examples:

  1. Everyday items, such as food.
  2. Durable goods, such as clothing.
  3. Services, such as insurance.

These products, are a key factor used to calculate it.

Everyday products weight more than others to calculate inflation. So, we can say that inflation is the sum of how prices for goods change over time and how they are weighted.

When inflation rises, it means that people are paying more money to buy the same goods than before.

We can say that inflation sucks when a Starbucks coffee gets even more expensive, but it is an important part of a consumer economy as the U.S.

When prices continue to rise, there is a sense of urgency to buy today as opposed to buying tomorrow in the hopes that prices drop. This is a major driver of the US economy.

As with everything, there’s a catch. As with many things, too much or too little of a good thing is bad.

Too little inflation, an economy can slow and even shrink. You’ve probably heard something about Japan’s economy not being so great for the last 20 years or so. Too little inflation or deflation is a major cause.

On the other hand, too much inflation and people’s salaries can’t keep up to buy bread. You’ve probably seen pictures of people in Germany with a shopping cart full of money to (ironically) go buy a carton of milk. More recently Zimbabwe and Venezuela have experienced hyperinflation (inflation that is out of control).

So when your friend starts complaining about how expensive their Big Macs are, you can tell him about inflation. You won’t be his favorite person for that, but at least he’ll learn something :)

Pablo de Miguel