Section 4-5: Inflation, Taxes, and Stocks

Welcome to Section 4-5, where we'll explore the crucial aspects of personal finance: inflation, taxes, and stocks. Understanding these concepts is vital for making informed financial decisions and securing your financial future. Let's dive in!

Understanding Inflation

Inflation is an increase in the general price level of goods and services in an economy over a period of time. Deflation, conversely, is a decrease in prices.

The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. It's a key indicator of inflation.

The rate of inflation is measured by the percentage change in the CPI over time. We can calculate it using the following formula:

$$ \text{Percentage change} = \frac{\text{Changes in CPI}}{\text{Previous CPI}} \times 100\% $$

Example: Suppose the CPI increases this year from 200 to 205. What is the rate of inflation for this year?

  1. The change in CPI = $205 - 200 = 5$.
  2. The percentage change = $\frac{5}{200} \times 100\% = 2.5\%$.

Thus, the rate of inflation is 2.5%.

Buying Power and Inflation Formula

Inflation erodes the purchasing power of money. Here are the formulas to determine the buying power:

Buying Power Formula:

$$ \text{Percent decrease in buying power} = \frac{100i}{100 + i} $$

Where $i$ is the inflation rate expressed as a percent (not a decimal).

Inflation Formula:

$$ \text{Percent rate of inflation} = \frac{100B}{100 - B} $$

Where $B$ is the decrease in buying power expressed as a percent (not a decimal).

Understanding Taxes

Taxes are a crucial part of personal finance. Understanding how taxes are calculated can help you make better financial decisions.

Example (calculating the tax): In the year 2000, Alex was single and had a taxable income of $70,000. How much tax did she owe?

According to the 2000 Tax Table for Singles, Alex owed $14,381.50 plus 31% of the excess taxable income over $63,550. The total tax is:

$14,381.50 + 0.31 × ($70,000 - $63,550) = $16,381.00

Dow Jones Industrial Average (DJIA)

The Dow Jones Industrial Average (DJIA) is a stock market index that tracks 30 large, publicly-owned companies trading on the New York Stock Exchange (NYSE) and the NASDAQ.

For every $1 move in any Dow company's stock price, the DJIA changes by about 7.56 points.

Example (Finding changes in the Dow): Suppose the stock of Walt Disney increases in value by $3 per share. If all other Dow stock prices remain unchanged, how does this affect the DJIA?

Each $1 increase causes the average to increase by about 7.56 points. So, a $3 increase would cause an increase of about $3 \times 7.56 = 22.68$ points in the Dow.

We hope this section has provided you with a solid foundation in inflation, taxes, and stocks. Keep practicing, and you'll become a savvy financial manager in no time!