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Inflation and buying power

Why the same dollar buys less over time, and what that means for your savings.

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Inflation is when prices rise across the economy. When that happens, each dollar has less purchasing power: it buys a little less than it used to.

A little inflation is normal. The Federal Reserve aims for about 2% a year. But when inflation runs higher, people notice it fast, at the grocery store, the gas pump and in rent.

Inflation matters for savers, too. If your savings account pays 1% while prices rise 3%, your balance grows, but what it can buy shrinks. To keep up, money needs to earn at least the inflation rate. The interest rate you earn minus inflation is roughly your "real" return.

Words to know

Write what each word means in your own words.

1. Inflation
2. Purchasing power
3. Interest rate

Questions

1. A video game costs $60. If prices rise 5% this year, what will it cost next year?
2. Prices rise 3% a year. Fill in about how much a $100 basket of groceries costs over time. Round to the nearest dollar.

   Year	Cost of the basket
   0	$100
   1
   2
   10

3. Your savings account pays 1% a year and inflation is 3%. Is your money gaining or losing buying power? By about how much each year?
4. An investment earns 5% in a year when inflation is 3%. About what is the real return?
   1. About 8%
   2. About 5%
   3. About 2%
   4. About −2%
5. Who is usually hurt most when inflation rises unexpectedly?
   1. People who owe money at a fixed rate
   2. People living on a fixed income or holding lots of cash
   3. Companies that can easily raise their prices
   4. Nobody
6. Name one price you've noticed going up recently. How did you or your family adjust?

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