Do you remember when a gallon of gas cost about a dollar?
Or when a family of four could go to a Red Sox game for less than hundred dollars? Ah! Those were the days.
Prices going up over time is a simple fact of life that we have all come to accept. We grow up hearing our grandparents regaling us with tales of their youth when a loaf of bread only cost a nickel. And of course I expect we will be wowing our grandkids in 2040 with stories of how cheap stuff was in the olden days too.
When we find ourselves waxing nostalgically about the low prices of yesteryear we are thinking about real inflation. The most common statistic used to track real inflation is the Consumer Price Index (CPI) which tracks the price of a "representative basket of goods and services" over time. This is the number you hear on the news. It is also the number we use in our financial plans to ensure we adjust your future spending needs appropriately.
When the CPI goes up from one period to the next it is called inflation and when it goes down it is called deflation.
Why do prices go up?
Prices go up over time for a few reasons:
- The good or service becomes more scarce. If the supply dwindles but demand stays high prices go up. Oil is a great example of a scarce resource.
- Demand increases but supply doesn't. There are only so many seats at Fenway Park and more people want to buy tickets than there are seats available. Expect the Red Sox to keep raising prices.
- The cost of providing the good or service becomes more expensive. Raw materials and labor are themselves scarce resources. Workers need to buy gas to drive to work and they want to take their kids to the Red Sox game on the weekend, both of those things are more expensive than they used to be. Cost of living increases in normal economic environments are fairly commonplace and almost always passed on to the consumer.
Do you remember when most households had only one television?
Do you remember life before cell phones, iPods and WiFi networks in the home? I remember when we got our microwave, dishwasher, VCR, cable TV, and I even remember when we got our first push button phone. Life was different then wasn't it?
I still remember my Great Grandmother telling me the story of the first time she saw an automobile. Can you even imagine how amazing it must have been for her to see how the lifestyles of average people improved over the course of her lifetime? The minimum standard of living in the poorest of homes in America today is likely well beyond her wildest girlhood dreams.
This phenomenon is called personal inflation.
Most of us lived for years without many of the things we now see as necessities in our lives. My children for example will never know a world without air conditioning, yet I didn't have A/C until I got married. And this expectation of an air conditioned world will require them to consume more electricity in their lifetime than I will in mine.
Technological advancements and increased comfort are wonderful things. You won't see me going back to window fans anytime soon. But understanding the controllable nature of personal inflation is just as important to your financial future as the realization that real inflation will eat away at your purchasing power if you fail to account for it.
It is also important to recognize that personal inflation and real inflation are linked. As our minimum standard of living increases so will our required wage to support that living increase. The higher wage requirement will drive up the costs of the standard basket of goods and services we produce which will in turn increase the cost of the goods we consume.
One way to tilt the odds in your favor in this cycle is to be more cognizant of both your personal inflation and your consumption of scarce resources. In this way you can take advantage of the increased wages that will come with time while avoiding potential cost expansion for items that may not provide you with true value in your life.
What do you think? Are you paying more attention to personal inflation these days? What are some products or services that fall into the personal inflation category that you simply can't live without?