Inflation Overview Basic understanding of Inflation
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- Let's say I'm an economist
- and I'm curious about whether in general
- things are getting more expensive or not
- and if they are getting expensive, by how much?
- So the way I'd approach that is I would think of
- well what are just a bunch of goods and services
- that the average person would buy
- So I would think up some type of basket of goods
- goods and services
- And I would try to weight that basket based on
- how people actually spend their money.
- So I'd say, okay, 40% of peoples' money on average
- is spent on housing.
- Maybe another 10% is spent on transportation,
- maybe another 10% is spent on food
- and I would go out into the market
- and I would see, I would try to take an average
- of what these things cost. And I would sample
- a bunch of products, a bunch of services,
- so that I get a decent average of that
- So this is not a simple thing to do,
- but I'm an economist and I'm serious about trying to calculate that
- And let's say that when I take that weighted average
- of all of this stuff, I just come up with a number.
- And this is, I'm not giving you the details
- of how it's actually calculated,
- but to give you the idea of what they are doing.
- So I get a number, so I just, you know...
- to rent, to buy or lease your average automobile
- to lease your average apartment
- to buy your average servings of food
- for a given family, all the rest...
- let's say I come up with that costs
- and I'm making up a number here,
- let's say that it costs $20,000
- my basket of services,
- just based on the way that I've weighted it.
- And this is all happening in year 1.
- So this is in year 1.
- Now I'm curious whether between year 1
- and let's say year 5,
- whether things got more expensive
- So I'll take that same basket of goods and services
- So basket of goods and services
- and I'll try to figure out what is their weighted average cost in year 5
- and this is a lot harder than it sounds right now
- because the basket of goods and services change
- If computers get faster, do you use the same computer?
- Or do you think about what the average computer is
- which would now be a better computer.
- If most people's TVs got bigger, do you use the same TV
- in year 1 and year 5? Or do you adjust now the average TV
- which has now gotten bigger.
- If houses have gotten bigger on average, do you use the same house?
- Or do you use the average house?
- So there's a whole bunch of areas here
- that you could really tweak (change),
- and these are actually huge subjects of debate
- on what is the actual increase in cost.
- But let's say that you're able to do this
- in what you think is a pretty reasonable way
- and you find that the same basket of goods
- adjusted for things like technology and all of the rest,
- Now costs $22,000. So your takeaway
- from here is the same things that cost $20,000
- the things that give you the same standard of living in year 1
- to get that same standard of living in year 5
- you now need to spend 10% more
- it's gotten $2,000 more expensive off of $20,000
- so it's gotten 10% more expensive
- So you as the economist
- what you would say is, as the way you've defined it
- your consumer price index, and this is abbreviated with CPI
- Your consumer price index is up by 10%
- Another way, based on the way you measured it
- and it change from country to country
- even within countries, they change the way
- that they do these baskets of goods,
- but by the way you've measured it,
- you would say that the price inflation has been
- 10% between year 1 and year 5
- or in general, everything got 10% more expensive
- or you would 10% more money to have the same standard of living
- and in general, when people are just refering to
- inflation, so if you just see the word inflation being referred to
- they are referring to price inflation,
- this general increase in the price of goods and services
- measured by some type of basket of goods.
- There is another type of inflation, and that is
- monetary inflation
- and they are related,
- monetary inflation is inflation due to purely the increase of the money supply
- So this is increase in money supply.
- And in general, if this increase in the money supply
- does outstrip kind of the productive capacity of the country
- it could very well lead to price inflation
- but in general, what people measure,
- when they talk about inflation from one year to the next
- they're talking about this basket of goods
- they're talking about price inflation.
- The other thing that you'll sometimes see
- maybe in year 5, someone says, "hey!"
- "I could sell you this house"
- this house is in year 5
- "I could sell you a house"
- and this house in year 5 is $660,000
- and someone might ask, well
- "What would be that price if we adjusted it for inflation in year 1 dollars?"
- So what they're saying is, you adjust for how much value
- your money has lost.
- Because if things are getting more expensive that means
- each dollar is being worth less.
- You can buy less with each dollar.
- So when people say, "How much is that adjusted to inflation in year 1 money?"
- You're essentially saying,
- What amount of money would that house have had to have cost in year 1,
- that when you adjust it for inflation
- you increase it by 10%, so that's the same thing
- increasing by 10% is the same thing as multiplying by 110%
- or multiplying by 1.1
- So what amount of money would that house have had to have cost in year 1
- that if I multiply it by 1.1, I get $660,000?
- Now we can do a little quick math here to figure that out
- So if we say, let's say that, I don't know
- that P, P is the price of the house in year 1
- I'll call it P1, that times 1.1
- is going to be equal to $660,000
- When you factor in the 10% inflation over these years
- Now this is simple algebra right here
- You could divide both sides by 1.1
- and we get, these cancel out
- you get the price of that house in year 1
- 66 divided by 11 would be 6
- now you can work it out with a calculator if you don't feel comfortable enough
- with what I'm about to do.
- This would give you $600,000, if you work this math right out here
- And you could figure out the decimals,
- what we could do, well, I think you get the general idea here
- you can use your calculator. I kind of did this in my head
- But the general idea is a house in year 1 that is $600,000
- if you factor in the devaluing of the current year
- or how much more expensive everything got in year 5
- will cost you $660,000.
- So you might hear someone say
- when they're talking about inflation or they're talking about price increases
- This house in year 5 is $660,000
- which is equal to $600,000 in year 1 money.
- And as an example of that,
- you know I live in neighborhood where
- the houses have gotten all of a sudden
- because I live in the heart of Silicon Valley
- it's not a fancy neighborhood by any stretch of the imagination
- but the house are now quite expensive
- and we have neighbors now that moved in in the 1950s,
- and they say, "My god, I bought my house for $10,000 and now people are selling these houses for
- so much more!"
- And the reality is is that it is true,
- the house has appreciated,
- but $10,000 in 1950 was actually a lot
- a lot of money.
- Doctors and engineers did not make that much more
- than that much per year.
- I don't know the exact amount.
- So the reality is, is that you actually have to
- adjust money for the year you are talking about
- and you have to adjust it for inflation
- So if you believe this 10% inflation number
- Hopefully people's incomes also increased by the same amount
- So the same person, maybe with the same skills
- and the same job, who could afford
- the house for $600,000 in year 1,
- could now pay $660,000 for it, and it won't take
- an unusually large chunk of their expenditures
- it would take the same chunk that it did in year 1.
- So hopefully that clarifies things a little bit,
- and I'll in the future do more videos
- going into the details of inflation
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