You will be able to explain purchasing power and show what steady inflation does to a fixed sum over ten years.
Ask your parents what a plate of chicken rice cost when they started work, and they will give you a number that sounds like a different country. Ask yourself what your usual lunch cost when you were in university, and the gap is smaller but it is there. Nobody changed the size of the plate. The dollars just do less than they used to.
That is inflation, and it is the reason a savings balance that never goes down can still leave you poorer. This lesson shows you how it works and what it does to a fixed sum over ten years.
Inflation is a general rise in prices across the economy over time. The word "general" matters. One item getting more expensive, such as durian in a bad season or concert tickets for a popular act, is a price change in one market. Inflation is when prices across most of what people buy drift upwards together, so that the same shopping basket costs more this year than last.
When economists say inflation was 3% in a year, they mean that a typical basket of goods and services cost about 3% more at the end of the year than at the start. Some things in it rose more, some less, and a few may have fallen.
The flip side of rising prices is falling purchasing power, which is the amount of goods and services a sum of money can buy.
Your bank balance is measured in dollars, so inflation does not touch the number on your screen. What changes is what that number can do. Suppose you keep S$10,000 in a drawer for ten years while prices rise 3% a year, a rate chosen for this example. At the end, you still have S$10,000. But things that cost S$10,000 at the start now cost about S$13,439, because 1.03 to the power of 10 is about 1.344. Turned the other way, your S$10,000 now buys what about S$7,441 bought ten years earlier. You have lost about a quarter of your purchasing power without spending a cent.
At 2% a year, the same S$10,000 buys what about S$8,203 bought at the start of the decade. At 4%, it buys what about S$6,756 bought. Small differences in the yearly rate become large differences over a decade.
Those figures came from the same formula you used for interest in lesson 2.1, Simple interest pays on what you put in, compound pays on what you earned. Each year's price rise applies to prices that already rose the year before. So inflation compounds, and the tools for compound interest work on it directly.
That includes the rule of 72 from lesson 2.3, Estimate doubling time in your head with the rule of 72. At 3% inflation, prices double in about 72 divided by 3, which is 24 years. At 2%, it takes about 36 years. At 4%, about 18. A 30-year-old today can expect, at 3%, to pay twice today's prices for the same things by their mid-fifties. That is worth knowing before you decide how much cash to hold for the long term.
Inflation does not move at a steady rate. It has been low for long stretches and higher for others, and nobody can tell you next year's figure with certainty. The examples in this lesson use fixed rates to show the mechanism, not to predict anything.
In Singapore, the Department of Statistics publishes the Consumer Price Index, the CPI, which tracks the prices of a basket of goods and services bought by households. The headline inflation rate you see in the news is the change in this index over a year. You can find the latest figures on the Department of Statistics website, SingStat.
MAS also publishes a measure called core inflation, which leaves out the cost of accommodation and private transport. Those two categories can swing sharply because of property and car market changes, and taking them out gives a steadier picture of everyday prices. You will meet both measures again in the course How the economy hits your wallet: rates, inflation and cycles, which explains how MAS uses them. For now it is enough to know that two official figures exist, and to check which one a news story is quoting.
Official figures are averages. The clearest way to feel inflation is to look at what you yourself pay. Most people have a few prices they remember well from years ago: a meal they ate every week, a monthly phone bill, a haircut, a cinema ticket, a taxi ride home. Think back about ten years and pick some of those memories, then set them against what the same things cost now.
Pick three things you bought ten years ago, find or estimate today's price for each, and calculate how much more you now pay.
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