How to calculate Inflation and Example

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The price index options listed above can help determine inflation rates between specific months or years. Although many inflation calculators are available on different financial sites, it’s important to understand the methods behind them to ensure accurate calculations. Here is How to calculate Inflation. Mathematically,

Percent Inflation Rate = (Final CPI Index Value ÷ Initial CPI Value) x 100

If you want to see how the value of $10,000 changed from January 1975 to January 2024, you can look up price index data on different websites. Find the Consumer Price Index (CPI) numbers for those two months. The CPI for January 1975 was 52.1, and for January 2024, it was 308.417.

Percent Inflation Rate = (308.417 ÷ 52.1) x 100 = (5.9197) x 100 = 591.97%

To find out how much $10,000 from January 1975 would be worth in January 2024, you need to multiply the inflation rate by the amount to calculate the new dollar value.

Change in Dollar Value = 5.9197 x $10,000 = $59,197

This indicates that $10,000 from January 1975 is equivalent to $59,197 today. In simple terms, if you bought a set of goods and services worth $10,000 in 1975, that same set would cost you $59,197 in January 2024.

Example

All currencies around the world are fiat money, meaning the money supply can grow quickly due to political factors, leading to fast increases in prices. A well-known case of this is the hyperinflation that affected Germany’s Weimar Republic in the early 1920s.

The countries that won World War I asked Germany to pay reparations. However, Germany’s paper money was not trusted because the government had borrowed a lot. To settle their debts, Germany tried to print more money, buy foreign currency, and use that for payments.

This policy caused the German mark to lose value quickly, leading to hyperinflation. German consumers reacted by spending their money quickly, knowing it would lose value if they waited. More money entered the economy, causing its value to drop so much that people used nearly worthless bills to decorate their walls. Similar events happened in Peru in 1990 and in Zimbabwe from 2007 to 2008.

Factors That Lead to Inflation.

Inflation mainly happens for three reasons: demand-pull inflation, cost-push inflation, and built-in inflation.

  • Demand-pull inflation happens when the supply of goods and services is lower than what people want, leading to higher prices.
  • Cost-push inflation occurs when the costs of making goods and services go up, which makes companies increase their prices.
  • Built-in inflation, also known as a wage-price spiral, takes place when workers ask for higher pay to match rising living expenses. This leads businesses to raise their prices to cover the higher wages, creating a cycle of increasing wages and prices.

Conclusion

Inflation raises the prices of products, especially if salaries don’t rise at the same rate. It also lowers the worth of some assets, mainly cash. To control inflation, governments and central banks apply monetary policy.