The 3 Types of Inflation:
Price, Cost, and Built-In

There are three types of inflation that impact every investor. Whether the effects are good or bad depends on whether you're looking to invest money, or you've already invested it.

Keep in mind that the "types" of inflation are not the same as the "causes" of inflation. The causes create the types. Learn more about the relationship between the two on my Causes of Inflation page.

What is Inflation?

Inflation is defined as the sustained or gradual rise in general prices.

Prices naturally fluctuate over time, but a consistent increase is an indicator of inflation.

Sometimes, inflation is in your face, like when you buy gas. But most of the time, it creeps up on you very slowly.

Your online checking account won't tell you how much more your could have bought last year for the same amount of money.

Instead, you'll find yourself thinking that cars cost a lot more than they did 10 years ago, or your family vacations seem to get more and more expensive each year.

The best example is baby boomers talking about buying candy bars for a nickel. Does ANYTHING cost 5 cents these days?

This is the reason that inflation is often referred to as the "silent" or "stealth" tax.

You don't really notice that your money doesn't go as far as it used to, until it doesn't go as far as it used to!

The 3 Types of Inflation

The types of inflation are different than the "causes" of inflation. To save you time and money, you must understand The most common definitions for the types of inflation are:

  1. Price Inflation
  2. Cost Inflation
  3. Built-In Inflation

1) Price Inflation

Price inflation is a rise in the price your willing to pay.

Maybe something you want is in short supply, so you're willing to pay more to get it.

Like those Kid Rock tickets that sold for $20 at Ticketmaster and seconds later appeared on StubHub for hundreds of dollars.

Price inflation is good after you've invested your money, and bad if you're looking to invest.

2) Cost Inflation

Cost inflation is a rise in price you're forced to pay.

If you're buying a gold engagement ring and the price of gold spikes, you're going to pay more for the ring because the gold used to make it costs more.

Cost inflation is also good after you've invested your money, and bad if you're looking to invest.

3) Built-In Inflation

Built-in inflation is a rise in price "just because".

Your salary is the "price" your employer is willing to pay for your time. If you're like most people, you expect a raise every year.

Why? Because you and everyone else got one in the past.

If you're doing more work, then you expect more money (even more built-in inflation).

Built-in inflation is good when you're looking to invest, but not so great after you've invested.

Taking the work example to completion...if you're not going to get a raise because the economy is bad, you're probably not going to invest the time/effort it would take to get one.

Finding out there is no raise or promotion after you've invested your time isn't pleasant.

Is Inflation Always Bad?

Some people automatically think that inflation is always bad, but this is not always true.

If you work hard and get a raise, you just created some good inflation (unless it puts you in a higher tax bracket...but that's another web page!).

The following examples describe situations when inflation is bad, manageable, and even good.

3% Inflation = Bad

  • You want to buy a $100 watch. By the time you've saved $100, watch prices are 3% higher ($103).

3% Inflation = Manageable

  • You invested $100 at a 5% return. After 1 year, your investment is only "worth" $102 ($100 + ($100*(5%-3%)), because prices also increased.

3% Inflation = Good

  • You own a $100 watch. After 1 year, your watch is worth $103.

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