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How does inflation affect consumers

how does inflation affect consumers

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Inflation Defined

At a given moment, the U.S. Consumer Price Index (CPI) stands at a given level; The U.S. Bureau of Statistics calculates this level monthly and releases a detailed breakdown of changes in those levels on a month-to-month seasonally adjusted basis. In February 2010, for example, the Bureau released the Consumer Price Index for February and noted that "the Consumer Price Index for all Urban Consumers was unchanged in February," and that over the last 12 months the index had increased 2.1 percent. This increase in the consumer index establishes the inflation rate--or rather it establishes one of many inflation rates based on various prices indexes. Other reports track increases in many areas, including durable goods prices, manufacturing costs and commodity prices. The U.S. Consumer Price Index, however, remains the most regarded and most influential indicator of the inflation rate.

Inflation Statistics: What Counts

Note that discussions of inflation always have to do with the inflation rate; the absolute level of inflation at a particular time has less effect upon personal income and consumer prices. If, as in the early 1970s in this country, the rate of inflation soars to a high level, but then stabilizes, the stability of the rate would have more effect upon business and consumers than the fact that it had soared. The rate of change in the CPI counts more; the absolute CPI level counts less.

Why Does the Rate of Inflation Matter?

Inflation always adversely affects consumers. Why? Let's suppose you have a job in a widget plant, where you earn $10 per hour. If the inflation rate increases, your employer's cost of materials will rise from, let's say, $1,000 to $1,100, which adversely affects his profit margin--he's still selling the widgets for a dollar, but now his costs have risen by about 10 percent, so he makes less profit per widget. He can hardly give you a raise. To counter his lowered profit margin, he raises his widget prices. This same routine repeats at the consumer level: the store pays your boss more for widgets and then, responding to lowered margins, charges more. Still earning $10 per hour, you go to the store to buy the widget, but now discover that the retail price has increased from

$3 per widget to $4. You're still earning $10 per hour. Your earning power has decreased because of inflation.

The Inflationary Spiral

Since you can't buy as many widgets for you and your family as you used to buy, you want a raise. Your employer will likely resist; when he raised his widget price in response to increased materials costs, he didn't increase his profit margin--he simply restored the profit margin he used to have before his material costs increased. Economists call his struggle between employers to retain profit margins by holding down wages and the opposing efforts of employees to raise wages to restore their buying power the "upward pressure on wages" that accompanies an increasing inflation rate. When your employer eventually gives in and gives you a raise--probably less than you wanted and less than you needed to regain the earning power you had before materials costs rose--he then has to raise his prices again; the retailer will then have to do the same. Economists call this "the inflationary spiral." The inflationary spiral hurts everybody because earning power always lags behind price increases, leaving everybody with less earning power than they had before. When it gets bad enough it becomes what one economist calls "The Cycle of Doom."

The Stable Economy

Deflationary spirals also hurt economies; Japan has suffered several deflationary spirals in the past 20 years with generally unhappy and sometimes very strange results. At one point, for instance, the lending rate in Japan dipped below 0 percent--theoretically, at least, your bank paid you to keep their money. Stable economies, on the other hand, with a slowly increasing inflation rate--1 or 2 percent annually--help everyone and particularly consumers because you can count on the future value of your money and you are not chasing an inflationary spiral that always leaves you with less buying power than you had only a short time ago. For example, the widget that costs $1 this year will probably cost only a few cents more next year, so you can base buying decisions on need rather than on the fact that next year you may not be able to afford the widget. Your employer's material costs rise slowly, giving him the ability to raise his prices slowly and to gradually increase your wages.

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