The 101 Financial Lessons Newsletter

 


Topic: Understanding Inflation 

Topic of the Week - Inflation

Inflation, which is expressed as a percentage rate, is an economic term used to describe the rise in the prices of goods or services, over a period of time, usually annually.

In general terms, inflation is caused when there is an excess amount of money available in the market place and a shortage of goods and services to spend it on. Excess amounts of money are available in market place during times of high employment where more people are earning money. They are investing and spending their money on the same quantity of goods available, thus increasing the price (supply and demand), and therefore creating inflation.

In the United States, inflation is measured by the Consumer Price Index (CPI). The CPI is a weighted measure of prices for products and services including food, housing and utilities. Since the change in price of milk, butter, meats, etc. will affect the consumer differently than the price of a candy bar, the average change in price is weighted to give a fair reading.

According to the Economic History Resource (http://www.eh.net) the inflation rate for 2005 in the United States was 3.41%, 2004 was 2.68% and 2003 it was 2.28%.

Note: Many public employees receive a "cost of living adjustment", in reality they are receive an adjustment for inflation.

Real Value of Money

Over the years, the actual cost of products have increased. We  have all heard the stories (and you may be telling them yourself) "I remember when a movie was ten cents or a bottle of Coke was
a nickel". The change is price is the result of Inflation.

We have all heard that a "dollar today, will not be worth a dollar tomorrow". This is the concept known as the Real Value of Money.It shows the cost of inflation against your investment or
savings account. The calculation below will show you how much purchasing power your money will have in the future.

In general, if we were at a 4% inflation rate, the cost of goods and services that you would purchase with today's dollar would cost 4% more next year. Each dollar would have a purchasing
power of $ 0.96 ($1.00 - $.04 = $0.96) one year later.

How does this affect your savings account or CD? If you have $1,000 in a savings account which would pay 1.5% APY this year and inflation was 4%. The purchasing value of your money would
be $975 even though your account shows a balance of $1,015.

We will be using simple calculations for educational purposes,
which does  not include taxes.

Interest: Multiply $1,000 times 1. 5% = $15 (interest) or $1,015
at the end of one year.

Cost of inflation: Multiply $1,000 times 4% = $40

Real Value of Money: Subtract $40 (inflation) from your actual
balance $1,015 or $1,015 - $40 = $975.

Did you know that the value of $1 in 1970 was the same as $4.56
in 2001; or the same $1 in 1946 was worth $9.09 in 2001. You can
find this the information on the Economic History Resource web site
(http://www.eh.net).

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III. Teaching Inflation

Our suggested method for teaching inflation is experiential. The
child should visualize the effects of inflation first hand, to do this
we would recommend using real currency. As a teacher you should
have a $1 bill, two quarters, two dimes, four nickels and ten pennies.

We recommend having a discussion with your child or class about
inflation and how can effect your purchases.

Talking points may include:

  • The concept that a dollar today is not worth the same
    dollar tomorrow.
  • Everyone is effected by inflation.
  • Save your money in an interest bearing account, if not in a CD or
    Money Market, which may pay more than the current inflation rate.

After the class or individual discussion, use the money as an example.
Have them deposit the $1 bill into an "account" with you. Explain to
them that one-year has passed and give them back 96 cents (4% inflation).

Have them re-deposit the 96 cents, explain that the second year has
passed and give them 92 cents. Do this for five years and your child
will understand the basics concepts of Inflation.

(1st year - 96 cents)
(2nd year- 92 cents)
(3rd year - 88 cents)
(4th year - 85 cents)
(5th year - 82 cents)

Note: For older students, you may want to include interest payments
of 2% per year.

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IV. Learning Activity

Goals:

To help students recognize how inflation increases the cost
of goods and services

Tools:
  • Paper
  • Pencil
  • Visit to the Library
  • Visit the Grocery Store

 

Skills used:
  • Research
  • Problem solving
  • Comparison shopping
  • Discussion

 

Directions:

Step 1.

Visit your local library and request the microfiche on the local
newspaper for the day or week that you were born. Ask the
librarian for help in setting up the microfiche reader.

Step 2.

Fold a piece of notebook paper in half (the long way) creating
two columns. On the top of the left-hand column, write the
day and year that you were born and on the right hand column,
write today's date.

Go through each page of the newspaper and look for advertisements
for the following products. Write the name, size and cost of each
product that you find on the list.

  • 1 gallon of milk
  • 1 pound of sugar
  • 1 can of coffee
  • 1 pound of chicken (breast)
  • 1 pound of hamburger
  • 1 loaf of white bread
  • 1 2 litter bottle of Coca Cola

Step 3.

On your next trip to the grocery store, take your notebook page
and compare the prices from the day that you were born to today's.

Step 4.

Answer the following questions:

1. What product had the largest increase in price?

2. In all prices were to be increased by 5% this year, what
    would there cost be next year?

3. What did this exercise teach you?

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Thank you for being a subscriber!
Enjoy the rest of your week.

Timothy Liptrap
Vice President, 101 Financial Lessons

The 101 Financial Lessons Newsletter



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