Why your money shrinks.
The story so far Your bike stall from the last lesson did well, and now you have savings sitting in a drawer. Then your grandpa mentions that a movie ticket cost about $2 when he was 17. Today it's about $11. Your cash is still all there. So why will it buy a little less every year?
Measuring how fast prices rise (inflation) and how much a whole country produces (GDP).
Money that just sits there slowly loses value. And if your pay goes up less than prices do, you're actually worse off.
Track the price of a "basket" of everyday things over time. Then adjust money amounts for it, turning nominal dollars into real buying power.
Government economists measure it. Macro strategists at banks predict it so investors can plan.
What you're looking at: a sketch, not real data. The basket's price tag keeps rising while the same $100 bill buys a smaller basket. The note shows the math: with 3% inflation a year, $100 buys about $74 of today's stuff after 10 years.
Travel through time.
Watch prices climb.
Drag the slider through the years. Each year shows what today's prices would have been back then. These come from the Consumer Price Index (CPI), which the government uses to measure what a typical basket of groceries, rent, gas and other everyday things costs.
- CPI
- The basket is scaled so it cost $100 in the early 1980s. The same basket cost $38.80 in 1970 and about $313.70 in 2024, so the CPI was 38.8 in 1970 and 313.7 in 2024.
What $100 from 2024 would have been worth in that year: the green bill. The further back you go, the more a dollar bought.
What you're looking at: real CPI data from 1970 to 2024. The slider picks a year. The basket shows what today's prices would have been that year, and the green bill shows what $100 from 2024 was worth back then, drawn bigger or smaller to match.
And GDP: everything a country makes in a year.
GDP adds up the value of everything made and sold in a country in one year. The US made about $29 trillion worth in 2024. Economists split it into four pieces, each with a letter:
- C, consumption: what households spend, like groceries, phones and bikes from your stall.
- I, investment: what businesses spend on things that help them make more later, like machines and buildings. New houses count here too.
- G, government: what the government spends on things like roads, schools and the military.
- NX, net exports: what we sell to other countries minus what we buy from them.
Tap a piece of the bar to see what's in it.
GDP = C + I + G + (X − M). Tap a piece.
What you're looking at: real US GDP for 2024, about $29 trillion, as one bar. Each piece's width is its real share: consumption 68%, investment 18% and government 17%. Net exports are about −3%, so they sit under the bar as a small amount taken away. 68 + 18 + 17 − 3 = 100%.
Two minutes. Just listen.
Tap any line to jump to it.
Beat Inflation
A time machine drops you into five real years from history. Each year you make two choices: how much to raise your bike price, and where to keep your $1,000 of savings. Then you'll see what prices actually did that year. To win, your real money (what it can buy) has to grow, not just the number of dollars.
What you're looking at: your savings over the years you play, with years along the bottom and dollars up the side. The dashed gray line is the dollars in your account. The green line is what those dollars can really buy after inflation.
The logic, step by step.
The inflation rate
The inflation rate is how much the CPI went up, as a percent. Take how much it grew, and divide by where it started. If the CPI goes from 200 to 210, it grew by 10, and 10200 = 0.05, so inflation was 5%.
- Inflation rate
- The CPI goes from 200 to 210: 210 − 200200 = 10200 = 0.05, so inflation was 5%.
What causes inflation
There are two main kinds. Demand-pull inflation happens when everyone tries to buy more than the economy can make, so sellers raise prices. That happened in 2021, when people had extra money from stimulus checks. Cost-push inflation happens when making things suddenly gets more expensive, like when oil prices jumped in 1973 and 1979. Over many years, prices also rise when a country prints money faster than it makes stuff: more dollars chasing the same goods.
- Demand-pull
- 2021: people had stimulus money and wanted cars, but factories couldn't make enough, so used-car prices jumped over 30% in a year.
- Cost-push
- 1973: oil prices roughly quadrupled, so gas, shipping and anything made from plastic cost more to make, and prices rose.
Why aim for 2%, not 0%?
The Federal Reserve (the US central bank, covered next lesson) aims for about 2% inflation a year. A little inflation is safer than deflation, when prices fall. Falling prices sound nice, but people put off buying things because they'll be cheaper later, businesses sell less, and people lose jobs.
- Deflation
- In the Great Depression, US prices fell by about a quarter from 1929 to 1933, and about 1 in 4 workers lost their jobs.
Moving a price through time
To see what an old price would be today, multiply it by how much the CPI has grown since then. The CPI was 38.8 in 1970 and about 313.7 in 2024, so prices grew about 313.738.8 = 8.1 times. A $2 movie ticket in 1970 is like about $16 today.
The rule of 70: how fast prices double
Here's a quick way to find how many years it takes prices to double: divide 70 by the yearly inflation rate. Use the percent as a plain number (3, not 0.03). At 3% inflation, that's 703 ≈ 23 years, so something that costs $100 today would cost about $200 in 23 years. At 7% inflation, it's 707 = 10 years. The higher the inflation, the faster prices double.
- Rule of 70
- At 3% inflation, the $100 basket costs about $200 after 703 ≈ 23 years.
The CPI isn't perfect
When something gets expensive, people often switch to a cheaper option, and products keep getting better (a phone today does far more than one from 2010 for similar money). So the CPI may make inflation look a little worse than it feels. On the other hand, your own inflation depends on what you buy. Rent and college tuition have gone up faster than average.
Real vs. nominal
A nominal number is plain dollars. A real number subtracts inflation, so it shows what you can actually buy. If your savings account pays 4% but prices rise 3%, your money only really grew about 1%.
- Nominal
- Your savings account pays 4%. That's the plain-dollar number.
- Real
- Take away the 3% inflation: 4% − 3% = about 1%. That's how much more you can actually buy.
The exact formula
"Real ≈ nominal − inflation" is a shortcut. The exact version, called the Fisher equation, is (1 + nominal) = (1 + real) × (1 + inflation). With 8% interest and 5% inflation, the real rate is 1.081.05 − 1 = 2.86%, a bit less than the shortcut's 3%. The difference only matters when the numbers are big.
- Fisher equation
- 8% interest with 5% inflation: (1 + 0.08) = (1 + real) × (1 + 0.05). Solve: real = 1.081.05 − 1 = 2.86%.
Worked example: was it a raise?
- Look up the CPI. It averaged 292.7 in 2022 and 304.7 in 2023.
- Find inflation. It grew by 304.7 − 292.7 = 12. Then 12292.7 = 0.041, so prices rose about 4.1%.
- Look at the raise. Say your pay went from $18.00 to $18.36 an hour. That's 36 cents more, and 0.3618 = 0.02, a raise of 2% in plain dollars.
- Subtract inflation. 2% − 4.1% = −2.1%. You're getting more dollars, but prices went up even more, so you can buy about 2% less than before. It's really a pay cut.
- Work out what would keep you even. To keep up with 4.1% inflation, your pay needed to rise to $18.00 × 1.041 = $18.74 an hour.
- Nominal raise
- $18.00 to $18.36 is +2% in plain dollars.
- Real raise
- 2% − 4.1% inflation = −2.1%. In buying power, it's a pay cut.
GDP
GDP is the four pieces added up: household spending, business investment, government spending, and exports (X) minus imports (M).
GDP can also be real or nominal. If GDP in dollars grew 5% but prices rose 3%, the country only really made about 2% more stuff. When real GDP shrinks for two quarters in a row (six months), people usually call it a recession.
- GDP
- For the US: household spending (C) is about 68% of GDP, business investment (I) about 18%, government (G) about 17%, and exports minus imports (X − M) about −3%. Together they add up to 100%.
- Recession
- In early 2020, businesses closed for COVID and real GDP shrank two quarters in a row. That was a recession.
Cash in a drawer is a pond in summer.
A pond with no stream feeding it loses water to the sun every day. You don't notice from one day to the next, but by August the shore has crept in. Inflation evaporates money the same way. Interest is the stream. If the stream runs slower than the evaporation, the pond still shrinks.
What you're looking at: an illustration, not data. The left pond has no stream, so the sun slowly dries it up, like cash losing value to inflation. The right pond has a stream flowing in that keeps it full, like savings earning interest.
Why this sticks. Hydrologists measure evaporation against inflow to know if a lake is healthy. Do the same with your money: compare what it earns against what inflation takes. That one habit is the whole reason people invest instead of hoarding cash.
The page you'd copy down.
- Inflation: prices rising across the economy. Each dollar buys less, which means it has less purchasing power.
- CPI: the cost of a fixed basket of goods and services, tracked monthly by the Bureau of Labor Statistics.
- Inflation rate = % change in CPI. The Fed targets about 2% a year.
- Nominal = in raw dollars. Real = adjusted for inflation. Real ≈ nominal − inflation.
- Rule of 70: a quick way to find how many years it takes prices to double. Divide 70 by the inflation rate. At 3% inflation, 703 ≈ 23 years.
- GDP: the value of everything a country makes and sells in a year. GDP = C + I + G + (X − M): household spending + business investment + government spending + (exports − imports).
- Real GDP strips out price changes. Growth in real GDP = the economy actually making more.
- Recession: when the economy shrinks for a while. A common rule of thumb is two quarters (six months) in a row of falling real GDP.
Fill in the blanks
Grab a friend or a study group.
Interview the past
Ask a parent or grandparent what they paid for a car, their first apartment and a gallon of gas, and when. Convert each to today's dollars with the formula. Which one grew faster than inflation, and why might that be?
Build your own CPI
Each person lists five things they buy every month and today's prices. Look up (or guess) prices from five years ago. Whose personal inflation rate is highest? Students who pay rent usually win this one.
Era showdown
Each of you plays Beat Inflation in a different era. Compare: in which decade was cash in a drawer the worst idea? Explain it to each other using real vs. nominal.
Just you and your buying power.
These stay on this device. Nobody else sees them.
Exam-style questions.
Written the way a college exam would ask them. Each right answer on the first try is worth 10 xp.
On the job: you're the macro strategist
A client keeps $200,000 in a savings account earning 0.5%. Inflation is running at 4%. The client says, "At least I'm not losing money."
Your task: show the client, in dollars, how much buying power they lose in one year. Then explain in two sentences why "not losing money" isn't true.
See a model answer
Real return ≈ 0.5% − 4% = −3.5%. On $200,000, that's about $7,000 of buying power lost in a year (exactly: 200,000 × 1.0051.04 ≈ $193,269, a loss of $6,731).
The point: the balance goes up by $1,000, but prices go up by $8,000. The client has more dollars and can buy less with them, so in real terms they are losing money every month the cash sits there.
Inflation sets up everything about rates.
What you're looking at: a map of where this lesson fits in the course. Read it left to right: what comes before, this lesson in the middle, and the later lessons that build on it.
- Before · Unit 8Supply and demand
- You are hereInflation and GDP
- Next · Unit 9Interest rates
- Later · Unit 10Compounding
- Later · Unit 14Portfolios
- Later · Unit 16Macro and the Fed