Module 8 of 8 12 min
Inflation
Why prices rise, what it does to the value of your money, and how to think in "real" terms.
Course lessons
Step 1
The lesson
Inflation is the general rise in prices over time. When prices rise, each dollar buys a little less. That's a loss of purchasing power.
In the U.S., inflation is commonly measured with the Consumer Price Index (CPI), published by the Bureau of Labor Statistics. It tracks the prices of a big basket of things people buy — food, rent, gas, clothing, and more.
Why do prices rise? Usually some mix of: people wanting to buy more than is available, costs going up for businesses (like wages or materials), and more money flowing through the economy.
Some inflation is normal. The Federal Reserve aims for inflation of about 2% a year over the long run. High inflation is the problem: it hurts savers and people whose income doesn't keep up.
Key term
Real return
What your money earns after accounting for inflation. A rough estimate: your interest rate minus the inflation rate.
This is why money that needs to last a long time — like retirement savings — usually has to grow faster than inflation. Cash sitting still for decades quietly loses value.
Step 2
See it
With 3% inflation each year, $100 of today's purchasing power falls to about $74 in 10 years, $55 in 20 years, and $41 in 30 years.
Step 3
Real-world example
When a raise is really a pay cut
Two quick situations that show why you have to think in real terms:
- Savings: Your account pays 1% interest while prices rise 3%. Your $1,000 becomes $1,010 — but things that cost $1,000 now cost $1,030. You can buy about 2% less than before.
- Pay: You get a 3% raise, but inflation is 5% that year. Your paycheck is bigger, but it buys about 2% less. In real terms, that's a pay cut.
Numbers that go up aren't always gains. Always ask: up compared to what prices are doing?
Step 4
Try it: inflation calculator
See what something costs in the future — and what today's money will be worth — at a hypothetical inflation rate.
Your numbers
The Federal Reserve aims for about 2% over the long run.
Results
What $100 of stuff costs in 10 years
$134
Same things, higher price
What $100 buys in 10 years
$74
In today's dollars
At 3% a year, money that sits still loses about 26% of its buying power over 10 years. To keep up, it needs to earn at least 3% a year.
Educational calculator, not financial advice. Results are hypothetical estimates based on the numbers you enter.
Step 5
Knowledge check
Answer each question, then check your answer to see the explanation. Retake it as many times as you like.
Question 1 of 3
Step 6
Summary
Inflation is the general rise in prices, which shrinks what each dollar buys. Compare any return or raise to inflation to see the real change. Money meant to last a long time generally needs to grow faster than inflation.
Step 7
What you should remember
- Inflation = rising prices = each dollar buys less.
- Real return ≈ your return minus inflation.
- The Federal Reserve aims for about 2% inflation over the long run.
- Long-term money usually needs to grow faster than inflation.
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