Inflation and the Plaid Shirt

This is the story of how a very cute plaid shirt inspired Lisa to save more for the future. 

Lisa and Beth were shopping together when Beth spotted the shirt and knew it would look great on Lisa. But when Lisa saw it, she had a flashback to the 1990s, the last time plaid shirts were trendy. The new shirt cost $50 and Lisa remembered paying $30 for similar shirts back then. So the word ‘inflation’ popped into Lisa’s head.

Inflation describes price increases over time. Lisa realized that not only do shirts that used to cost $30 now cost $50, but many things that used to be $30 now cost more. With inflation, the same number of dollars buys less. So the price of a shirt, as well as other things like haircuts and groceries, can rise.

Imagine that inflation is 4% per year: this means that prices rise 4% every year. An item that costs $100 at the beginning of a year will then cost $104 at the end of that year. This might not seem like a big deal, until you consider that everything costs a bit more, on average. Therefore, if your paycheck doesn’t grow at the same rate, you won’t be able to buy as much as you used to at the higher prices.

“If your paycheck doesn’t grow at the same rate [as inflation], you won’t be able to buy as much as you used to at the higher prices.”

 
When Lisa had her plaid shirt ‘aha’ moment, she realized that prices had risen, and that they’re probably going to be even higher in the future. Her friend Beth understood that part, too. But Beth couldn’t figure out how the same shirt could go all the way from $30 in the 1990’s to $50 now, when it feels like prices rise only a little each year.

Lisa explained that this happens because price increases build upon one another. Let’s say prices increased 4% every year for 20 years. A $100 bag of groceries will cost $104 after one year. After 10 years, it will cost $148, and the 4% just keeps adding up to more and more money, so that after 20 years, your $100 bag of groceries costs $219. In other words, your $100 groceries cost more than twice as much 20 years later.

Cost of Groceries

Lisa knows that, when she thinks about how much money she’ll need for the future, she must also take into account how much more things will cost. Reminded by her new shirt, she’s happy to have understood inflation, and she recognizes that knowing more about how to manage money will be important for her financial future.