Definition
Inflation is the rate at which the general level of prices for goods and services rises, causing purchasing power to fall. As inflation increases, each dollar buys fewer goods and services. The most common measure of inflation is the Consumer Price Index (CPI), which tracks the price changes of a basket of goods and services. Moderate inflation is considered normal for a growing economy, but high inflation can erode savings and fixed incomes.
Formula
The inflation rate is calculated as the percentage change in the Consumer Price Index over a specific period, typically annually.
Example
Inflation Impact Example
If inflation is 3% annually, a basket of goods that costs $100 today will cost approximately $103 next year, $106 the following year, and about $134 in 10 years. This means $10,000 in cash today will only have the purchasing power of about $7,440 in 10 years if inflation averages 3%—demonstrating why investing to beat inflation is crucial for preserving wealth.