In our ever-changing economy, the one constant that seems to persist is the fluctuating nature of prices. Whether it's the cost of groceries, fuel, or housing, prices have a tendency to rise over time. In this post, we'll explore the reasons behind the phenomenon of rising prices and discuss practical strategies for individuals to navigate through inflationary periods.
In order to understand the change in prices, many economists and consumers alike look to a single metric: the Consumer Price Index, or CPI for short. This number measures the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. In simpler terms, it reflects the changes in the cost of living for a typical household. Therefore, this index takes a holistic view on prices, giving a well-rounded measure of how prices are changing. If you are interested in seeing how this metric is calculated, take a look below.
Basket of Goods and Services:
The CPI is based on a predetermined basket of goods and services that represents the spending habits of the average urban consumer. This basket includes items like food, clothing, rent, healthcare, transportation, and other goods and services.
Price Collection:
The Bureau of Labor Statistics (BLS) collects price data for thousands of items in the basket each month. Trained personnel visit stores, service providers, and rental units to record the prices of these items.
Weighting:
Not all items in the basket have equal importance. The CPI assigns weights to each item based on its relative importance in the average consumer's budget. For example, housing costs might have a higher weight than entertainment costs.
Calculation:
The CPI is calculated by comparing the current total cost of the basket to the cost of the same basket in a reference or base period. The percentage change in this cost over time represents the inflation or deflation in the overall price level.
CPI =(Cost of Basket in Current Year ÷ Cost of Basket in Base Year) × 100
CPI Data
Although knowing how to calculate something is helpful, it does not help you understand what is actually happening in today’s economy. That is why many people and economists alike look at the graphs.
Above is a graph of the CPI changes over the years, starting from January 2020. In this graph, Jan 2020 is considered the base year, thus given a value of 100. But what does all this mean? Using the CPI formula referenced before, we can estimate how much prices are truly rising on average. Taking the highest point in the graph, 119 in August 2023, and the lowest point, 100 in January 2020, we can find the percent change.
% Change = (119 - 100) ÷ 100 × 100 = 19%.
This means that the price of the market basket, or the general price for various goods and services has increased by 19%.
However, it is extremely important to realize that this one number is not all encompassing, and some goods have increased in price, while some have even decreased.
There are many reasons why prices rise and fall. Since these fluctuations directly affect our daily lives, it's imperative to have a general understanding as to why this happens. Below are four of the primary drivers behind price increases.
1. More People Want Less Stuff (Supply and Demand):
Imagine everyone suddenly wants the same new device or a trendy snack. If there's not enough of it, the price goes up. It's like when your favorite game or concert tickets are in high demand: the prices can shoot up because everyone wants them. For example, remember the craze over the Taylor Swift Eras Tour? The face value, or standard price, of the tickets was just $253.56. However, the show was in so much demand that people started to buy the tickets to resell them. Since the amount of tickets available, supply, was so low, and the amount of people who wanted them, demand, was so high, the resellers were able to jack up their prices at insane amounts. In fact, the average resell price of the tickets was $3,801, which is almost fifteen times the original price.
2. Making Stuff Costs More (Cost Push Inflation):
Think about making your favorite pizza. If the ingredients like cheese and pepperoni get pricier, the pizza place might need to charge you more to keep making a profit. When the stuff needed to make things gets more expensive, those costs can get passed on to you, the customer.
3. Money Stuff (Monetary Policy):
Imagine this: the school decides to give everyone extra lunch money. Suddenly, everyone has more money to spend. But if there's still the same amount of pizza and sandwiches, people might start bidding more for their lunch. This extra money circulating can sometimes make prices go up. That's how the government's decisions about money can affect prices in the real world.
4. World Events Matter (Global and Political Events):
Sometimes, things happening far away can impact prices close to us. For example, when there's trouble in an oil-producing place, it can make gas prices go up. And if it costs more to transport goods, the prices of those goods might rise too. Our world is connected, so what happens globally can affect what we pay for things locally. This effect is especially true in today’s economy, as a single product usually sources its parts from many different countries.
Understanding these basic ideas helps us see why prices change. It's like having a map to navigate through the world of prices going up and down. In the next part, we'll look at some simple tricks to handle when prices start climbing in our everyday lives.
Now that we know how to tell when prices rise, and why prices rise, it’s time to dive into how to adjust when everything starts costing more.
1. Budgeting for Financial Control:
Develop the habit of financial planning, creating a budget that outlines your income and expenses. This systematic approach helps you understand your spending patterns and identify areas where you can cut back or save. It is also important to dedicate part of your budget towards savings, as having an excess reserve of money helps take the stress away from poor economic times.
2. Thoughtful Shopping Practices:
Enhance your consumer skills by comparing prices, looking for discounts, and considering loyalty programs. Strategic shopping allows you to make the most of your money and make informed purchasing decisions. In addition, tying into creating a budget, keep your old shopping receipts, to track how the prices of the items you frequently buy change. If an item is suddenly much more costly, then you can exactly see how much it costs more, allowing you to make better shopping decisions.
3. Smart Investment Choices:
Investing your money can be a great way for “beating” inflation, which in simple terms means that the combined value of your money does not decrease as inflation occurs (more on investing and inflation in a future article). However, investing can possess great risks, especially during troubling economic times. Venture into the realm of investment with careful consideration. Diversify your portfolio, spreading risk across different assets. Understanding the principles of wise investing is like planting seeds for future financial growth.
4. Thoughtful Consumption Decisions:
Exercise prudence in your consumption choices by opting for quality, comparing options, and thinking about the long-term impact of your decisions. By purchasing quality items, you are, in most cases, able to ensure that you are able to buy a product that will last a long time. When choosing low-quality items, you run the risk of having to replace that item multiple times, creating an overall higher cost than if you would have just bought the quality item. Furthermore, it is important to think about what are “needs” and what are “wants”. Needs are necessities, that you can not live your life without: e.x. a home, food, transportation. Wants are nice for one to have, but are not necessary to live: e.x. going to an expensive concert, purchasing luxury items, etc. Making thoughtful choices aligns your spending with your overall financial goals, ensuring excess wealth, which is especially important during periods of rising prices.
In the ever-shifting economic terrain, rising prices are a given, but so is our ability to navigate them with financial intelligence. Understanding the forces behind price hikes and adopting practical strategies form the compass for our journey towards a safe and wealthy financial future.
In managing the complexities of economic choices, we have the opportunity to create stability. Rising prices present challenges, but they also prompt us to cultivate growth, adaptability, and enduring financial well-being.
As we navigate economic shifts, let practical strategies be our guide, leading us toward a future where stability and financial responsibility take precedence.
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