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The inflation fee components and easy methods to calculate it

You might have heard your grandparents say that the prices of goods and services used to be much cheaper, and you might have imagined how great it would have been to pay 5 cents for a cup of coffee, or even 30 cents for a gallon of gas . Why have prices soared since then and why do you have to pay almost ten times as much? The answer to that is inflation.

Understanding inflation is important as it affects every aspect of the economy, from consumer spending to investment returns. With consumer prices expected to rise 4.8% over the next year, meaning you'll soon be paying more for things like housing and groceries, knowing what to expect in the future will help you manage your finances better . In this guide, we're going to break down the inflation rate using simple terms so you know how to calculate inflation using the inflation rate formula.

What is inflation rate?

Inflation is the concept that over time the prices of goods and services increase and the value of currency decreases.

Let's say you saved $ 7 in your wallet and you want to buy a gallon of milk. If you decide to buy it now, and it costs $ 3.50, you could buy two gallons of milk. However, if you decide to save the $ 7 in your wallet and use it to buy milk later, chances are the gallon of milk won't cost you $ 3.50. Instead, it could cost $ 3.80, so you can only buy a gallon of milk. This means that your purchasing power has decreased due to inflation.

As a consumer, you are part of the economic cycle, and it is important to understand the fundamentals of inflation to understand how fluctuations in the cost of living affect your wallet over time.

Why inflation happens

Price changes due to inflation can occur in any industry and at any time. Typically, inflation occurs due to an increase in the cost of production or an increase in demand. Price fluctuations can occur for a number of reasons, such as: B. by over-printing the dollar, and sometimes the price of one good will go up and another will go down.

In general, the many factors that can cause inflation fall into three categories:

Demand pull inflation

When more goods and services are in demand than the economy can produce.

example: Consumers want to buy milk, but farmers do not have enough supply, which leads to rising milk prices.

Cost push inflation

As the cost of producing goods and services increases, so do the prices of those goods and services.

example: The tools and materials required for milk production became more expensive, which also increased the price of milk.

Built-in inflation

When workers expect their salaries to go up to keep their cost of living down because the prices of goods and services have risen. These workers expect steadily rising prices and higher salaries, which contributes to rising prices for goods and services.

example: The price of milk is rising and consumers want to be able to afford it, so they are asking for a raise too.

The consumer price index

The most common index and indicator of inflation is the consumer price index (CPI), which is published by the U.S. Bureau of Labor Statistics is created. The CPI is used to assess changes in the cost of living over time. The price of each item – such as milk, eggs, energy, clothing, transportation, and medical expenses – is determined and averaged monthly. The CPI is then calculated by dividing the price of a basket in a given year by the price of the same basket in the base year.

The consumer price index is based on the index average from 1982 to 1984, which was set to 100. So if you see a CPI value of 140 it means a 40% increase in the level of inflation. At a value of 250, the inflation level shows an increase of 150%.

Inflation rate formula

To calculate the inflation rate, you need to use the inflation rate formula. This is a simple formula that you can use to see the percentage of cost increases or decreases between certain years. Once you understand the rate of inflation, it is easier to create a budget.

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<p>In the formula, A would be the starting point in the consumer price index for a specific good or service, which could either be a specific year or a specific month. And B would be the current entry in the consumer price index for the same good or service.</p>
<p>To use the formula, subtract A from B to find out how much the price of that particular good or service has changed. Then divide the result by A (the starting price) which gives you a decimal number. Convert the decimal number to a percentage by multiplying it by 100. The result is the inflation rate!</p>
<h3><strong>How to find the inflation rate for a specific period of time</strong></h3>
<p>Now that you understand how the inflation formula works, you may want to find out what the rate of inflation was for a certain period in the past, or even have an estimate of what you could pay for something in the future. Here are the steps you can use to find the rate of inflation:</p>
<h4><strong>Step 1: decide what you want to calculate</strong></h4>
<p>Decide which goods or services you want to analyze and for what period of time you want to determine inflation. You can do your own research or collect average price data from BLS.</p>
<p><strong>How do you</strong> <strong>it:</strong> Let's say you want to calculate the rate of inflation on a gallon of milk from December 1995 to June 2020. If you look at the CPI averages for milk, you will find that the average price for a gallon of milk in December 1995 was $ 2,518. and as of June 2020 it was $ 3,198.</p>
<h4><strong>Step 2: write down the information</strong></h4>
<p>When you have decided what to calculate, write it down neatly or make a graph. Make sure you know the price of the good or service for the start date you choose, as well as the price for the later date.</p>
<p><strong>December 1995</strong><br />
<strong>June 2020</strong></p>
<p>$ 2,518<br />
$ 3,198</p>
<h4><strong>Step 3: label the price points</strong></h4>
<p>After writing the information down, you will find that the formula contains the letters A and B. Label the price for the start date with A as this is the starting number in your formula. Next, label the second price with a B as this is the ending number.</p>
<p><strong>How it goes:</strong></p>
<p><strong>December 1995</strong><br />
<strong>June 2020</strong></p>
<p>$ 2,518 <strong>= A</strong><br />
$ 3,198 <strong>= B</strong></p>
<h4><strong>Step 4: plug it into the inflation formula</strong></h4>
<p>The final step is to just put it in the inflation formula and do the calculations. You subtract the starting price (A) from the later price (B) and divide it by the starting date (A). Then multiply the result by 100 to get the percentage of the inflation rate.</p>
<p><strong>How it goes:</strong></p>
<p style=Inflation rate = ((B – A) / A) x 100

Inflation rate = ((3.198 – 2.518) / 2.518) x 100

Inflation rate = (0.68) / 2.518) x 100

Inflation rate = (0.27) x 100

Inflation rate = 27%

How to determine the inflation rate using a base year

When you calculate inflation over a period of time, find the percentage change from the starting date, which would be your base year. However, you can use any year as the base year for calculating the inflation rate. If another year was selected, the index would also count as 100.

Step 1: Find the CPI of what you want to calculate

Decide which goods or services you want to analyze and for which years you want to find inflation. You can do this by using historical average price data or collecting CPI data from BLS.

If you decide to calculate with the average price of a good or service, the first thing you need to do is find the CPI for each of them by choosing a base year and using the CPI formula:

Value of the current shopping cart
VPI = –––––––––––––––––––––––––––––––– X 100
Basket value in the base year

How it goes: For example, suppose you want to calculate the inflation rate of a gallon of milk from January 2020 to January 2021, and choose January 2019 as the base year. If you look at the CPI averages for milk, you will find that the average price for a gallon of milk was $ 3.253 in January 2020, $ 3.468 in January 2021, and the base year (2019) price was $ 2.913.

Now you need to calculate the CPI for each of these years:

January 2019 (base year): (2,913 / 2,913) x 100 = 100
January 2020: (3.253 / 2.913) x 100 = 111
January 2021: (3,468 / 2,913) x 100 = 119

Step 2: write down the information

When you find the CPI numbers, write them down neatly or make a chart. Make sure you have the CPIs for the good or service for the start date, later date, and base year.

How it goes:

date
price
CPI

January 2019 (base year)
$ 2,913
100

January 2020
$ 3,253
111

January 2021
$ 3,468
119

Step 3: label the price points

After you have the information written down, label the CPI for the starting date with an A as this is the starting number in your formula. Next, label the CPI for the second date as B as that is the ending number.

How it goes:

date
price
CPI

January 2019 (base year)
$ 2,913
100

January 2020
$ 3,253
111 = A

January 2021
$ 3,468
119 = B

Step 4: plug it into the inflation formula

Now just plug it into the inflation formula and do the calculations. First, subtract the CPI for the start date (A) from the later date (B) and divide it by the CPI for the start date (A). Then multiply the result by 100 to get the percentage of the inflation rate.

How it goes:

Inflation rate = ((B – A) / A) x 100

Inflation rate = ((119 – 111) / 111) x 100

Inflation rate = (8) / 111) x 100

Inflation rate = (0.072) x 100

Inflation rate = 7.2%

More examples for calculating the inflation rate

1. You want to find out the inflation rate for bananas in March 2014 compared to July 2001. If the price of a pound of bananas was $ 0.52 in July 2001 and $ 0.59 in March 2014, the calculations would look like this:

Starting date: July 2001. Price: $ 0.52 = A

End date: March 2014. Price: $ 0.59 = B.

Inflation rate = ((B – A) / A) x 100

Inflation rate = ((0.59 – 0.52) / 0.52) x 100

Inflation rate = (0.07) / 0.52) x 100

Inflation rate = (0.07) / 0.52) x 100

Inflation rate = (0.1346) x 100

Inflation rate = 13.46%

2. Now let's find the gasoline inflation rate in July 2021 compared to January 2002. The price of gasoline was $ 1.13 per gallon in January 2002 and $ 3.23 per gallon in July 2021. You would first subtract $ 1.13 (A) from $ 3.23 (B) which is 2.1 and divide that by 1.13 (A) which gives 1.8584. To get the percentage, multiply it by 100, and the gasoline inflation rate in July 2021 versus January 2002 is 185.84%, meaning the price of a gallon of gasoline has more than doubled.

3. If you want to determine the inflation rate for electricity in January 2018 compared to January 2010. The CPI for electricity was 191,083 in 2010 and 213,023 in 2018. You would first subtract 191.083 (A) from 213.023 (B) which is 21.94 and divide that by 191.083 (A) which gives 0.1148. Multiply it by 100 to get the percentage which is 11.48%.

Now that you know the inflation rate formula and how to use it, you can apply it to making financial decisions. As a consumer, when you practice the formula and understand how inflation works, you can make important decisions about your cost of living and your future.

Sources: Bureau of Labor Statistics

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